Why the Fed will no longer be the big deal when it meets

12-12-2016

Why the Fed will no longer be the big deal when it meets

Like kids waiting for Santa, the one day markets have been thinking about all year is finally here. The Federal Reserve Open Market Committee on Wednesday is expected to announce an interest rate hike — its second in a year. It's also the second in 10 years, for that matter. However, the 25 basis point increase in the Fed funds target rate has become somewhat anticlimactic, not just because it's been so long anticipated but because there's a new game in town for investors. "The surprise of the Republican sweep of Congress along with the Trump administration has really changed consensus expectations almost 180 degrees. We really are focusing in on some of the impacts that some of the policy changes could have. We may be shaking up the economic world in terms of what we've been waiting for, what the Fed has even been saying — we need Congress and fiscal policy to do some of the heavy lifting here. I guess in some cases the Fed isn't really leading the story as much as they had in the past, and in some ways the Fed is really following the market right now in terms of raising rates," said Scott Anderson, Chief Economist for Bank of the West. In the week ahead, the Fed will hike rates after its two-day meeting, and the markets, not always happy with rate hikes, are set to take this one in stride. The real gift investors are waiting for and have been positioning for is the promise of individual and business tax cuts and an aggressive fiscal stimulus package from the incoming Trump administration. Stocks in the past week rallied, finishing Friday at record highs in the biggest indexes. The S&P 500 closed at 2,259, up 3 percent, in its best weekly gain since the election. The Dow rose 3 percent, ending at 19,756 in what has been a quick upward march toward the big round 20,000 milestone. The Nasdaq gained 3.6 percent to 5,444. At the same time, bonds sold off, with Treasury yields rising toward the high end of their recent range. The 10-year was at 2.47 percent in late trading Friday and the 20-year was at 1.12 percent. Fed Chair Janet Yellen will meet with the press after the Fed's 2 p.m. announcement Wednesday. Investors will be listening for her thoughts on how the economic agenda of the new administration could impact the economy and alter the course of interest rates. "My guess is [the meeting] is going to be the definition of a nonevent. I don't see any substantive changes coming from the Fed," said Deutsche Bank chief U.S. economist Joseph LaVorgna. He said the Fed does not need to change its rate forecast or economic outlook yet, as the details of the stimulus are still unknown. "They don't have to tweak things in any appreciable way. It will be a place holder for the meeting in March, because then we will be halfway through the president-elect's first 100 days," he said. LaVorgna said the stimulus could be a positive jolt for the economy, and it's yet to be seen if Yellen will let the economy run hot as she recently mentioned. The Fed chair suggested that the FOMC could tolerate a little more inflation and still keep rates low to make sure the economy picks up steam. He expects two rate hikes for next year, in line with the Fed's current forecasts. Anderson said the risk is that the Fed sound more optimistic, which would be hawkish in its meeting statement. "Optimistic in the sense that a lot of the growth concerns they've had following the Brexit vote, a lot of those things have come and gone, and so those downside risks to the global outlook have faded and that will give a green light for the Fed to move forward here," he said. "It's not just the U.S. We're seeing a synchronized global growth rebound here following the Brexit vote, which nobody had really factored into their growth forecasts." Some of the more hawkish Fed officials could view the Fed as behind the curve, and that could show up in the minutes of the meeting. The unemployment rate at 4.6 percent "might raise some eyebrows" among Fed officials, as it could be taken as a signal that the Fed has let the labor market improve too much without moving rates. Anderson said the Fed moving to hike rates as the economy improves would be taken as things "returning to normal" after the extraordinary easing of the post-financial crisis years. Anderson said the fiscal stimulus talk from Washington and tax cuts should help the economy. "We're cautiously optimistic for U.S. and global growth prospects for next year," he said. He revised 2017 GDP growth to 2.2 percent, and 2018 was raised by 0.5 to 2.3 percent. Besides the Fed meeting, there are several key economic reports in the coming week, including retail sales and industrial production Wednesday and housing starts Friday. There are also Treasury auctions Monday and Tuesday, for reopened three-year and 10-year notes and 30-year bonds. Some strategists say yields may have been moving higher ahead of those auctions. Both Anderson and LaVorgna view the move higher in yields and the steeper curve as healthy. The curve is the steepest it's been between the two-year and 10-year since last December. "They're not waiting for the Fed to move. I think it's a good sign. There's signs of sustained growth, global growth and U.S. growth," Anderson said. "We're going to be putting the financial crisis and the great recession in the rear-view mirror. It only took a decade." LaVorgna said the steepening yield curve is a positive. "Look at the rotation within the equity market, more toward cyclicals or those industries more sensitive to the economy. Those are the things I would focus on," he said. "We're at the steepest yield curve in a year. That to me is an unambiguous sign of faster growth." Financials led the market higher in the past week, gaining 4.8 percent. The S&P tech sector was second best, up 4.2 percent.