Fed Raises Interest Rates For Second Time In 2017

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Published Date 6/14/2017

The Fed did what was widely expected, increased the federal funds rate by 0.25% to a range of 1% to 1.25%. As is the usually the case, the analysis is running wild from economists. The policy statement was more data than normal, the question of course is, is the Fed on track with reality? It is the Fed, so not many are willing to step out and argue with it, especially with the optimistic outlook presented. Currently, the Fed expects another increase this year, three next year and three more in 2019; be careful here, that may be the reality over time, but we don’t believe the Fed or any other analytic body can look out three years with any degree of confidence...more wishful thinking.

Here are some key highlights of their announcement:

Economic activity has been rising moderately so far this year.
Household spending has picked up in recent months, and business fixed investment has continued to expand.
On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices is running somewhat below 2 percent.
Market-based measures of inflation compensation remain low.
The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.
The federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.
The Committee currently plans to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.

The Fed also revised the Policy Normalization Principles and Plans; looks now like the Fed will begin decreasing its reinvestment of the principal payments it receives from securities held in the System Open Market Account before the end of the year. The Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month. For agencies (mortgage securities) the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month. The Committee currently anticipates reducing the quantity of reserve balances, over time, to a level appreciably below that seen in recent years but larger than before the financial crisis. All looks promising based on the policy statement and the intent to begin emptying the Fed’s $1.4 trillion balance sheet but we can’t reach out that far in thinking. Mostly, the Fed wish list is based on hopefully expanding the US and global economic growth. Paying more than a passing interest in the Fed’s present longer term forecasts is for those that have time frames measured in years, not months. Below is the Fed’s current forecasts.

Two economic reports at 8:30 AM EDT; both weaker than expectations and both very key data points. May CPI -0.1% weaker than 0.0%, the core excluding food and energy expected +0.2%, +0.1% as reported. Yr/yr overall CPI +1.9% and ex-food and energy yr/yr +1.7%. Inflation based on this report is less than the May PPI yesterday. The big shock and bullish for interest rate markets; May retail sales. Retail sales were expected to have increased 0.2%, as reported down 0.3%; excluding auto sales expected +0.2%, as also reported down 0.3%. We are not unusually surprised with the weakness, we have noted a number of times consumers are not as enthusiastic about spending as what is believed by the elites in New York and Washington. That said, I admit I wasn’t expecting that much of a miss.

The Atlanta Fed’s GDPNow was updated today, frm GDP 3.0% on 6/9 to 3.2%. The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2017 is 3.2 percent on June 14, up from 3.0 percent on June 9. The forecast for second-quarter real consumer spending growth increased from 3.0 percent to 3.2 percent after this morning's retail sales report from the U.S. Census Bureau and this morning's Consumer Price Index release from the U.S. Bureau of Labor Statistics. The GDPNow will be updated again on Friday.

Tomorrow more key data; June Philadelphia Fed business index (27.0 from 38.8), May export and import prices (exports +0.1%, imports 0.0%), weekly jobless claims (242K from 245K), June Empire Sate manufacturing index (6.0 from -1.0), May industrial production and capacity utilization ( production +0.2% after increasing 1.0% in April, cap utilization at 76.8% from 76.7%).

OPEC’s output rose 1% to over 32.14 million barrels in May, led primarily by increases from three of its 14 members: Libya, Nigeria, and Iraq, according to the cartel’s closely watched monthly market report. Crude prices dropped to near a seven-month low on Wednesday after U.S. inventory data failed to convince investors that the global oil supply glut is easing. According to the EIA, crude oil stockpiles decreased by 1.7 million barrels in the week ended June 9, falling short of expectations for a 2.6 million-barrel drop from analysts. I guess it’s a broken record, but we do not believe crude prices have much upside; the same song, there is more oil than demand and no matter OPEC or any other news, oil has little chance of increasing to those forecasts six months ago back to $70.00/barrel. The price, however, does have a stop point, when the price is lower than costs to produce. Today crude dropped to $44.73 -$1.73 today. Crude is seen by many as a harbinger of inflation forecasts, not working for the Fed today, the Fed hangs on its belief inflation will increase.

On the day the FOMC meets the debates rise to fever pitch, opinions always a mixed bag and the defenses of positions take on more aggressive tones; we had that today. There is one thing to keep in mind when comparing ideas from one analyst to another; one economist and another….most everyone is comparing the outlook to historical performance. In that context whatever the opinions, based on how markets and economies performed over the last 70 years is where it fails the sniff test. The present and future will not mirror history; we are in another chapter. Comparing why wages are automatic to increase because the unemployment rate is 4.3%, worked in the past, not likely to be the same in the future. Economic forecasting is always based on an assumption to end at a conclusion; not sure history is a good base for any assumption.

The bond and mortgage markets fractionally weaker than at 9:30; given the hawkish Fed tone that interest rates held well and our tech models after reverting to neutral from bullish the last week, now back to strong bullish. The risk to being long bonds for near term is the 10 yr at 2.22% (8 bps higher than now). The risk holding MBSs is 24 bps from current levels.

Source: TBWS

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