- The FOMC increased rates 25 basis points, as expected.
- The FOMC increased the number of expected rate hikes in 2017 to three, a hawkish surprise.
Yesterday’s meeting largely met our “hawkish if” scenario as 1) The Fed hiked rates 25 basis points, 2) The Fed dots surprised markets by showing the expectation of three rate increases in 2017 and 3) Yellen’s press conference was slightly hawkish.
And, looking past the headlines, we believe there are two key takeaways from this Fed meeting: First, the Fed is more concerned with inflation than we thought in September. Second, it’s clear this new political paradigm is on the Fed’s mind, and it’s a hawkish influence.
Starting with the statement and projections (the dots) the key takeaway wasn’t just that the Fed upped its dots to reflect three hikes. Instead, it was why they upped the dots, and the reason is clear… inflation.
In yesterday’s statement, the Fed made three specific changes to its language that implied inflation was indeed accelerating. That means yesterday’s increase of the dots was in reaction to expected increases in inflation, which we take to further validate our call that inflation will be a major theme in markets as we enter 2017. So, from a positioning standpoint, despite the host of unknowns facing markets in 2017, higher inflation is something on which we can be relatively certain… so position accordingly.
Turning to the press conference, Yellen specifically said that employment conditions had returned to pre-crisis levels, and specifically said the Fed wasn’t trying to get the economy to “run hot.”
This was a surprise/shocking defense of Fed policy and and clearly meant to exhibit the Fed is not going to be blindly dovish going forward. Finally, Yellen said that large scale fiscal stimulus for an economy that’s already at full employment would likely result in more Fed rate hikes.
This was some of the most direct commentary I’ve seen from Yellen, and the fact that is came at the same time as the looking political changes is too much of a coincidence. So, while the new administration/government may not influence the Fed directly, it’s clear that any large scale stimulus will be met with more aggressive rate hikes by the Fed, which is obviously hawkish.
- November Retail Sales rose 0.1% vs. (E) 0.4%.
After a few months of very impressive gains, consumers took a bit of a breather in November, as not only did the headline miss expectations but so did the more important “control” category (retail sales minus autos, gasoline and building materials). Control retail sales rose 0.1% vs. (E) 0.3%.
Taken in the broader context, these aren’t “bad” numbers, as a rolling three-month average of control retail sales is still strong. But in the context of the recent ramp up in stock prices, this is not the type of acceleration in consumer spending that implies the economy is breaking out.
To that point, the Atlanta Fed’s “GDP Now” real time estimate of Q4 GDP fell following this retail sales report to 2.4% from 2.6%, and that’s not the kind of growth that will support the 10%-plus earnings growth that needs to occur to make market valuations make sense. From a market standpoint, there was a modestly dovish reaction to the data as the dollar dipped modestly and bonds rose, but yesterday’s data was not dovish, and will not affect the Fed’s strategy on rates.
Bottom line, the expectation/hope of growth-oriented policies from the new administration is still supporting stocks, but the more the current economic data remains uninspiring, the more vulnerable markets are to disappointment if that policy doesn’t match lofty expectations.