Fed Minutes Released: Stocks Decline
The Fed released its Minutes from the meeting from March 20th to the 21st. I consider it to be slightly hawkish because all the FOMC members stated they expected the economy to strengthen and inflation to rise in the coming months. The stock market had a moderate selloff in response to this release. The S&P 500 was down slightly when it was released and closed down 0.55% on the day. The negative day was blamed on Trump’s combative tweet towards Russia. It’s tough to assign blame on a day where the Russell 2000 was up 0.22%. It looks worse than it is because the Dow was down 0.9% as Boeing sold off 2.2%. If the combative threat was really thought of as something that could provoke a war, you’d expect Boeing stock to be up as it’s in the aerospace and defense cohort. It’s possible the market was slightly reversing the major gains from Tuesday which may have come too fast.
The Fed expressed worries about the potential trade war with China saying there is downside risk to the economy because of it. The Fed’s updated reaction would be interesting to hear since so much has happened since March 21st. I don’t think the tariff battle will cause any change to monetary policy unless there are further actions. I think cyclical weakness has a better chance of causing the Fed to hike rates fewer times than expected.
Fed About To End Accommodation Period
One of the big changes discussed in the Minutes was whether the Fed should change the language of its policy from accommodative to neutral or restraining. This is interesting because it will affect how the market reads policy guidance. However, I think the Fed is already neutral on policy. The Fed funds rate is 1.69% and the core PCE was up 1.6% year over year. To me, that is neutral policy even though the Fed funds rate is much lower than previous cycles. You also need to take into account the QE tightening policy path. As you can see from the list below, the Fed is ramping up its unwind from $20 billion per month to $30 billion per month in April. It will get to its peak of $50 billion per month in Q4. Including QET, the Fed is at a neutral policy and will shift to restraining the economy sometime in the next 12 months. If the Fed hikes rates 4 times this year, it will hit restraining in 2018.
Fed Ignores Economic Slowdown
Personally, I think it’s remarkable to see the Fed restrain the economy which is most certainly going to grow below 3% in 2018. Inflation also still isn’t at the target. Even though guidance focuses on the future, the Fed is often late to the game when it comes to rate of change movements. The Fed and the CBO most recently have ignored the current global economic slowdown. I’m not saying a recession is coming this year, but Q1’s GDP growth will be below the 2.7% target the Fed has and the 3.3% growth the CBO expects. The question is how low the growth needs to be in Q1 to change the Fed’s tone. As of today, there’s a 95.1% chance of a rate hike at the June meeting. Since the GDP report comes out in late April, the Fed will have access to it before the May meeting. In that meeting, it might decide to downplay rate hikes if GDP is weak.
GDP Now Suggests Weak Q1
The latest average of the blue chip estimates has fallen to 2.1% as you can see in the chart below. The Fed is acting like we are in early February when 3% growth was plausible. Now, it’s plausible growth is below 2%. As you can see, the GDP Nowcast from the Atlanta Fed has fallen from 2.3% to 2%. It’s a few tenths above its quarter to date low. The latest decline came because of the weak employment report as it caused the real consumer spending growth estimate to fall to 1.1% from 1.3% and the real private fixed investment growth estimate to fall from 5.3% to 4.5%. If consumer spending ends up growing at that rate, there won’t be much GDP growth as the consumer is 2/3rds of the economy. The big catalyst for a change in monetary policy could be the reports in March which make up the GDP report. GDP is simply a great summary of what is happening in the economy. You would think it would be unlikely to see the Fed decide to change its policy to hawkish after a GDP growth report below 2.5%. However, the Fed has ignored GDP in the past, so it’s certainly possible it says this slowdown is transitory.
Inflation Meets Expectations
The Fed stated the labor market strengthened and some areas saw wage gains, but the overall wage inflation was muted. According to the Atlanta Fed’s wage growth tracker, wage growth fell from 3.0% to 2.9% growth in February. The Fed expects inflation to hit its 2% target in the coming months. The CPI report for March was released on Wednesday. It showed month over month inflation was -0.1% which missed the consensus for 0% and last month’s 0.2%. This was the only category which missed. The year over inflation was 2.4% which met the consensus and was above last month’s 2.2%. Core CPI was 0.2% month over month which met the consensus and last month’s report. It was 2.1% year over year which met the consensus and was above the 1.8% increase last month. Based on this report, I could see core PCE increasing to 1.7% or 1.8% in March.
We are seeing a slow steady increase in inflation even as growth is slowing. This makes me wonder how high inflation would be if growth was accelerating. It could meet the Fed’s target and justify a hawkish policy. Therefore, an acceleration in growth is implied in hawkish policy. The Fed thinks acceleration will come from the tax cut and omnibus spending bill, but I’m skeptical because if they were going to cause growth to move up, why hasn’t there been an impact yet?
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