Stocks Rally After Fed Releases Minutes

S&P 500 Regains Some Losses

Even though it seems like tariffs weren’t in the news on Thursday, they were because they were mentioned in the Fed Minutes. Furthermore, there was tariff related news after the bell which might send stocks lower on Friday. Trump stated as much as $500 billion worth of goods could be subject to tariffs with China if the country retaliates after the $34 billion in American tariffs are implemented starting 12:01 AM on Friday.

The S&P 500 was up 0.86% on Thursday. It’s debatable how important this is because the market sold off into the 1:00 PM close on Tuesday on low volume. It’s easy for there to be meaningless big swings on holiday shortened days. The good news is the S&P 500 gained more on Thursday than it lost Tuesday. The Nasdaq was up 1.12% and the Russell 2000 was up 1.15% as it tries to repeat its remarkable first half in the second half of this year. Consumer staples and tech lead the market higher as they were up 1.46% and 1.47% respectively. Energy was the only loser as it fell 0.16%.

FOMC Minutes Have Something For Everyone

I mentioned that the headlines appeared to not be dominated by the tariffs for once. That was because the big news of the day was the FOMC Minutes. These Minutes were from the June 13th meeting. The Minutes are always interesting because it’s sometimes clear to see that the Fed was wrong on an event which occurred since then. It’s also fun to guess how the Fed will react to the news of the past few weeks now that we know its thoughts from about 3 weeks prior.

You can take quotes from the Minutes to support the narrative that the Fed is either hawkish or dovish. The Fed once again mentioned the tariffs as a reason to be cautious. As I mentioned previously, the one way the trade tensions’ impact on the stock market can be mitigated is if the tensions cause the Fed to be more dovish. With the great economic growth in Q2, the tariffs are an important cog holding the Fed from getting as hawkish as possible to stop the economy from overheating. To be clear, the Fed still wouldn’t be very hawkish because of its symmetrical approach to inflation, but these tariffs certainly temper hawkish rhetoric. Keep in mind, the trade tensions have escalated since the Minutes which means the Fed is likely leaning even more dovish because of them. The August meeting could see a dovish policy change if they keep escalating.

Let’s review some pivotal quotes from the Minutes. FOMC members “expressed concern about the possible adverse effects of tariffs and other proposed trade restrictions, both domestically and abroad, on future investment activity. Capital spending had been scaled back or postponed as a result of uncertainty over trade policy.” The effects of the tariffs will be seen before they are implemented because businesses don’t like uncertainty. If all the tariffs which have been enacted were the only problem, the economy wouldn’t be phased. If the threatened tariffs are all put in place, there could be a small slowdown in trade, but there won’t be a recession. The problem is the speed at which they are being amped up. The chart below shows the current and pending tariffs are meaningless to global trade, but the potential tariffs are something to worry about. The problem is the threats keep getting larger.

On the hawkish side, the Minutes stated the FOMC expressed “concern that a prolonged period in which the economy operated beyond potential could give rise to heightened inflationary pressures or to financial imbalances that could lead eventually to a significant economic downturn.” The Fed also said fiscal policy is “supportive of economic growth” and poses “upside risks.” As you can tell, the Fed is aware the economy is growing quickly and doesn’t want it to overheat.

Technically, the GDP growth of above 4% in Q2 is above the long run target, but even so the May core PCE only showed inflation of 2%. If the economy slows, which it should, it’s difficult to see inflation getting much higher after the year over year comparisons get tougher. I guess I’m simply not as bullish on inflation as the Fed. The economy would probably slow without Fed policy because it has slowed after every quick growth spurt in this expansion.

The Fed changed a boiler plate point at the end of its statement which had said that the funds rate would remain “below levels that are expected to prevail in the longer run.” This is logical because if the Fed hikes rates 2 more times this year, I think it will be hawkish. Very few economists will think the Fed is dovish after one more hike in 2019. Fed officials stated the funds rate could be “neutral” by next year. Maintaining forward guidance “was no longer appropriate in light of the strong state of the economy and the current expected path for policy.”

Market Reaction To Minutes

Considering the fact that the Minutes had hawkish and dovish language, it’s not shocking to see that the Fed funds futures didn’t change much after it came out. The chance of 4 hikes in 2018 moved up from 45.9% to 50.2%. There was marginal movement towards more hikes, but nothing different from any other day. Even though the chances of hikes haven’t moved much in the past few weeks, it’s possible that the tariffs have kept a lid on them. I think the chance of 4 hikes would be much higher if there were no tariffs.

There wasn’t much movement in the 10 year yield after the Minutes, but it remains very low considering the solid economic reports. Its low yield is causing an inversion to appear likely. The 2 year yield went up about 2 and a half basis points on Thursday which has pushed the difference between the two bond yields to just 29 basis points.

 

 

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2 Comments

  • James Teh

    July 8, 2018

    Many thanks Bro Don. I take note of what you said. I read your mail and it is meaningful.

    Many thanks

  • Sathyaprakash

    July 9, 2018

    Its really amazing & wondetfull