That FOMC statement had something for bears and bulls alike. Here are my big takeaways from the week:
- Inflation is the key going forward. The FOMC said they expect inflation to “decline further in the near term” but rise gradually toward 2% in the medium So no hikes in the near term. I have no idea what the FOMC considers the “medium term.” A quick Google search gave the result of medium term being two months to three years. Thanks Google… for nothing! That definition must’ve been written by Fischer. However, considering oil, the strong dollar, global deflation, global stagnation, structural efficiencies, and even the Fed’s own hawkish rhetoric are all working against inflation rising, I am not sure when we see that pick-up in inflation the Fed needs to see.
- The FOMC mentioned “international developments” in the statement. Things were looking bad globally at the December meeting and they chose to not mention it in the statement. They showed some concern in the Dec minutes, but for it to show up in the statement now reflects a greater degree of awareness/concern.
- The growth data was described as “solid” and “strong.” No doubt the data has been very constructive the past year. And it’s not as if the US couldn’t hike because some of its trading partners are not doing well. Japan was also facing deflation a decade ago, and the US still found a way to hike. We are data-dependent, so it will be interesting to see how the various stories mentioned in the first bullet play out this year. The growth side of the dual mandate is strong, while the inflation side is weak. I think there is a good chance many of the growth headwinds mentioned a few weeks ago will start appearing in the data.
- Bullard was out on the hawkish warpath Friday, saying it is reasonable to expect a rate rise in June or July. My favorite headline was “OIL PRICE DROP IS `UNAMBIGUOUS POSITIVE’ FOR U.S.” Umm… okay. Let’s see what happens – this is not clear to me. Much of his mid-2015 liftoff banter is based on him being a “Taylor Rule guy” at heart and a belief in the continuation of the growth trend. He mentioned that he expected unemployment to be under 5% in Q3, and his fear is that the FOMC may get behind the curve. It’s not clear to me when (or even “if”) we get to 5%, so this all goes back to “data dependent,” and one’s assumptions about data the first half of the year. He obviously does not see as many headwinds to the US economy as the rest of the market.
- I do not think Bullard’s view represents the consensus. Clearly he had some part in the growth upgrade in the FOMC statement. But he does not seem like he would have argued strongly for elaborating on the inflation picture, or adding “international developments.” So that means a number of other members would have had to have argued for it, and in particular, Yellen, Fischer, and/or Dudley – and those are the voices that matter most.
- Bill Gross expects a very slow rate hike starting July. He implied they may be hiking to early 2019, to a target of 2% (as per the yield curve). That’s around 50bps a year for 4 years. I guess he must be buying the greens. His quarterly GDP projections for this year are: 3% Q1, 3% Q2, 2% Q3 and 1% Q4. So basically the Fed is going to be snookered by strong growth the first half of the year into hiking and only BG knows the real truth of the subsequent collapse. What?!? Just for laughs, I too will pick numbers out of the air and I’ll go with 2.4, 1.8, 1.8, and 2 for the four quarters this year. Let the games begin!
- Keep an eye on the LIBOR cash fixing. It seems a little unusual that someone came in to sell 50K EDH5 late Friday. It was probably someone just wanting to take profit (or make profit) against locals who had put up too much size to game Globex into giving them a larger share of fills. But EDH5 should be effectively “dead” to a FOMC rate move with a March or April ease being highly unlikely. I don’t think there are any serious enough credit market situations right now (even in a bad-case scenario), to warrant a spike higher in the cash fixings, but we have a few countries who are itching to go bad (credit-wise), and it’s not clear what the repercussions may be.
- The central banks are squeezing the fixed income shorts. This is related to that theater analogy from last week. If one central bank does QE, it sees better. If a number of them do QE, they may or may not see better, but they definitely make it very uncomfortable for a lot of market participants. The central banks keep buying up large chunks of the attractive long end fixed income on the planet. While this could make alternate investments more attractive and stimulate investment and consumption, it could also end up interfering with the proper functioning of the markets. It’s not clear what the institutions who need to buy high quality securities (mutual funds, pension funds, insurance companies, other central banks, banks, etc) are supposed to do when there is not enough quality notes (and bonds) to go around – anywhere. I really wish the Fed would stop reinvesting in the long end ASAP, but it’s not clear what would make them change course.
Next week is chock full of good data: inflation data, the ISMs, ADP, and of course the Employment Report. If you are an interest rate bear, you need to see some signs of inflation – whether that occurs through the data or from some pieces of news (oil, Greece, Europe, China, etc). If you are a bull, either one of the following will suffice: (1) weaker growth data, or (2) continued weak inflation data.