FOMC: All options open

June 16, 2017 01:48 PM


The FOMC was a bit more hawkish this Wednesday. That is in spite of the fact that Fed Chair Janet Yellen is right that federal funds at 1.00%-1.25% are nominally accommodative compared to the Core U.S. Consumer Price Index data that just dropped back from 1.9% to 1.7% Wednesday hours before the afternoon FOMC announcements.

Yet, it is also the case which Chair Yellen and all other central bankers have always made that the central bank cannot get drawn into reacting when there is any minor aberration in the near term statistical context. Yet the Fed is dealing with still stubbornly weak inflation (like the Euro-zone and Japan) in spite of ostensibly (the operative term) improvement in U.S. and other countries employment picture. (More on that below.)

As Yellen once again emphasized in her press conference as well, the Fed remains confident that current sluggish growth is transitory. The FOMC Statement kind of summed it all up, with very little change from the previous indications. Those who are inclined can also review Janet Yellen’s full hour long press conference as well as the revised projections

Trump Factor is back

And the other factor returning after Tuesday’s positive influence from U.S. Attorney General Sessions’ Senate Intelligence Committee testimony is President Trump aggressively tweeting once again. That can be temporarily unsettling for equities at times. Along with recent weaker U.S. economic data, President Trump’s potential missteps with either misguided tweets or statements remain a key short-term risk for equities.

That may carry with it the potential for downward pressure to return to a U.S. dollar which has been buoyant (even if still only an upside reaction) since Wednesday on the back of the more hawkish Fed feel. And of course, any Trump disarray on top of the recent serial weak U.S. data will also continue to be supportive of the recently more buoyant govvies.

All of that relates back to the degree to which any sustained ‘Trump trouble’ distractions may continue to be an impediment to implementation of the very important administration reform and stimulus agenda. The key is that any major extension of the equities rally, any significant return to a more bullish U.S. dollar trend, and the potential for the long-awaited major govvies reversal into a bear trend are still contingent on Trump’s reform and stimulus agenda spurring further real U.S. growth.

Self-inflicted wounds

As we explored at length on June 7th's commentary (Self-Inflicted Wounds are Back post), Trump’s distractions are still an impediment to the accelerated U.S. growth his team keeps promising is just around the corner. It included key indications from (and a link to) the Organization for Economic Cooperation and Development’s (OECD) Semi-annual Global Economic Outlook released that morning, which is still showing only very modest current and future global growth gains.

This was reinforced by Monday morning’s latest OECD Composite Leading Indicators release. While the OECD analysts tend to take an upbeat view, the actual graphs and statistics show growth may actually be stalling in key countries. Those include the U.S., along with sustained weakness in China. And the point is that a global growth picture that was encouraged in an anticipatory manner by Trump’s election still needs U.S. growth to accelerate. Only that will support the upbeat valuations of equities (and U.S. dollar strength and a return of govvies weakness.)

That 2015-2016 "feel"

Of course, recent serial weak U.S. economic data, and the potential for the future reform and stimulus-based growth acceleration to fail leaves a still nominally accommodative FOMC looking a bit more hawkish. It has that ‘good old’ 2015-2016 feel to it.

For those of you who do not recall that phase, the Fed was proverbially way out over the tips of its skis’ on asserting that things were back to normal (what we termed the Fed’s "normalization bias" at the time) after years of low rates and quantitative easing (QE.) However, the post-Crisis recovery had so many U.S. government-imposed impediments to a typical strong post-deep recession rebound that the economy was not responding well in spite of the Fed’s massive QE liquidity injection and sustained low base rates.

And while the business environment has improved markedly in the wake of the Trump administration executive order regulation rollback, the real acceleration will likely only occur once there is more substantial tax and healthcare reform, and infrastructure spending stimulus. In the meantime, even the Fed is allowing it will remain (as always) ‘data dependent’. Note the minutes and Janet Yellen’s cautionary word on the ability to slow or even reverse shrinkage of its massive balance sheet if conditions should warrant (i.e. the U.S. economy somehow slides back into a weaker state.) 

The critical data dilemma

Also getting back to the 2015-2016 context, the Fed continues to assert that the U.S. Q1 growth weakness is transitory. Much the same as that previous phase, it is projecting growth returning to much more robust levels for the balance of 2017 into 2018, with commensurate base rate increases. Yet to project one more 25 basis point increase in 2017 and three more in 2018 is very aggressive in the context of current economic data returning to some real across-the-board weakness.

On recent form that includes weakness in the recent U.S. Employment report (including the key Hourly Earnings component), CPI Wednesday morning along with very important Retail Sales (which negated the previous month’s gains), Thursday morning’s Industrial Production, and Housing Starts released this morning as the latest shoe to fall.

The reason these are so important at this time is that Fed expectation is that weak U.S. Q1 growth is the typical seasonal occurrence seen over the past several years. That was followed by considerable recoveries once again beginning with Q2. Yet the latest economic data being released this month are spilling over well into the second quarter. Much more weakness in addition to those critical indications noted above would seem to point to a return to an overall sluggish economy.

As such, the balance of the economic releases this month into the key late month data like Durable Goods Orders, Personal Income and Spending, Consumer Confidence and of course the last of the U.S. Q1 GDP revisions will be more critical than usual. If they are stronger than the recent data, then the anticipation of at least moderate economic growth will be maintained. Yet any further weakness will encourage a more downbeat psychology for the economy and equities, even as the Fed allows all options are open.

Potential ironic twist

If weakness prevails, the Fed will look that much more overly anticipatory into an economic environment which does not support its outlook. Once again, this has that 2015-2016 feel to it. The one thing which might rescue the Fed’s aggressive view is the degree to which the President manages to finally stay out of his own (and Congress’) way so that his reform and stimulus agenda can indeed get passed into law.

The amusing bit there is Federal Reserve head Yellen confirming in her press conference what the FOMC meeting minutes said about the Fed not having incorporated any anticipation of government policy changes in its assumptions of consumer or investment spending. It would, therefore, be fairly ironic if Trump agenda success rescues the Fed from what at present appear to be overly optimistic assumptions, wouldn’t it?

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About the Author

Alan Rohrbach is Lead Analyst and President of Rohr International, Inc.  He is an international equity index, interest rate and foreign exchange trend advisor. His forte is ‘macro-technical’ analysis of how fundamental influences blend with technical aspects to drive trend psychology. Clients include international banks, hedge funds, other portfolio managers and individual traders.