Market Direction and Stock Trends

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Does Likely 2nd Fed Rate Hike Mean Return To Normal?
By Almanac Trader

* November 22, 2016

The CME Group FedWatch Tool, based on the 30-Day Fed Fund futures prices, is now projecting a 95% chance of the second rate increase of this tightening cycle as of today. It will be the first interest rate move by the Fed in just about a year. The first rate hike of this cycle last December was the first increase in over 9 years.

But the current FOMC’s laborious and deliberate style begs the question: Is his the new normal of highly micro-managed central banking or has the global economy become so large that slow growth is an unavoidable byproduct? I suspect it is a combination of fallout of the Great Recession, productivity gains from the information revolution dampening growth and inflation and a Fed that is petrified to make a wrong move that has brought us to this economic crossroads.

We opined on this topic last year that the end of ZIRP (zero interest rate policy) and its rather long life will likely solidify this data-dependent, passive-aggressive Fed policy philosophy. Perhaps it’s not really the Fed’s or other central banks faults? It could be the lack of progressive fiscal policy and dysfunctional federal governing around the world that has kept the lid on private sector growth. Or perhaps the global economy just grew too much too fast and this is a massive consolidation phase and the Fed is just keeping the pilot light on until we can kick it up a notch.

Whatever the case, political shake ups are happening around the world and Chair Yellen’s days are numbered with the new Trump administration unlikely to re-appoint her for another term in 2018. Despite what the Fed says about low inflation, we think real inflation that hits us all in the pocketbook and bank account is much higher, economic growth is gaining traction, and the stock market remains rather buoyant.

Official overall CPI inflation numbers show tepid inflation. However, official government data of the things that we all spend most of our money on: medical expenses, housing, food and energy is up 50-100% in the past 15 years. Not seasonally adjusted, Housing is up 48.3%, Medical Care is up 83.6%, Medical Services up 92%, Food up 48.6% and Energy is still up 67.2% (it was over 100% in 2014) since 2000.

If overall CPI inflation and GDP begin to perk up next year, Yellen and friends may feel compelled to move more rapidly to preserve their legacy and not be the ones that were behind the curve, missed the cues and let inflation run rampant again damaging the economy and the job market even worse.

In the updated table below, past interest rate tightening by the Fed has put pressure on the market. Declines 1-month and 3-months after the first increase were relatively mild. As we said last year, this cycle has the potential to deviate from history and surprise to the upside. It has so far. Prior tightening cycles had additional hikes in short order and rates increased rapidly to substantially higher levels.

If the pace and level of rate hikes is forced to accelerate, lower market prices would likely follow unless Mr. Trump and the new Republican Congress can work together to put the private sector back in the lead driving the economy like it has during boom times throughout history. I am rooting for them.



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