FOMC Meeting Observations
First of all, a belated happy St. Patrick’s Day. I don’t know about you, but I was eerily reminded of 2008, the last time St. Patty’s Day fell on a Monday, when markets managed through the news that J.P. Morgan paid $2 per share for Bear Stearns. That was quite a day for me as that evening was the very first time I sat on the desk for the full hour of CNBC’s “Fast Money.” Next time you see me in person, I do have some interesting stories from that afternoon.
Second, a belated happy St. Joseph’s Day, celebrated yesterday, to all of you who share my given first name. I always enjoy the wonderful pastries on this day and the knowledge that the official start to spring is just hours away. This year we had a little extra excitement on St. Joe’s Day, a Federal Reserve meeting highlighted by the first post-meeting press conference for new Fed Chair Janet Yellen.
My initial expectation for 2014 was that growth would accelerate here in the United States. I even suggested that consensus expectations of early 2016 as the timing of the first fed funds rate hike could be surprised by a much earlier hike in Q3 or Q4 2015. Over the past few months, the impact of dismal winter weather has challenged that optimistic view. Evidence to that challenge is the surprising decline in the 10-year U.S. Treasury yield (Figure 1) from 3.0516% on January 2 to 2.5680% on February 3.
Figure 1: U.S. 10-Year Treasury, December 19, 2013 to March 19, 2014
Yesterday, expectations were reset. The Fed seems to have dismissed the impact of lousy winter weather as transitory. I view both the language in the Fed’s statement and Dr. Yellen’s press conference as evidence that my view of when the first fed funds rate hike will occur has increased significantly in probability. The strongest support to that point was Dr. Yellen’s response to the question of how long after the asset purchase program ends would the fed funds rate stay in the zero to 25 basis point range? Her answer, “something on the order of six months.”
The central bank’s pace of Treasury and mortgage-backed security purchases rests at $55 billion, down from $85 billion just before the December 18, 2013 meeting. There are six remaining FOMC meetings in 2014. At the current $10 billion per month taper pace, the asset purchase program will be wound down by December 17, 2014. I actually suspect it could be sooner than that. Combine the taper path with Dr. Yellen’s response yesterday, and the first fed funds rate hike would be a mid-summer 2015 event, well ahead of the previous early 2016 consensus.
Remaining six FOMC 2014 meetings:
- April 30
- June 18
- July 30
- September 17
- October 29
- December 17
It wasn’t just Dr. Yellen’s press conference answer that should change timing expectations; I also found the Fed’s March Summary of Economic Projections, also released yesterday, suggestive of a quicker rate hike.
- Previous FOMC consensus for the end of 2015 fed funds rate was 0.75%; that has now been raised 25 basis points to 1.00%
- Previous FOMC consensus for the end of 2016 fed funds rate was 1.75%; that has now been raised 50 basis points to 2.25%
So while many will cite the Fed’s press conference commentary and statement language as suggestive of a continued vow to keep monetary policy historically easy, there has been a shift. That vow has been in place for years now and will remain so until the months leading to the first fed funds rate hike. The FOMC would never risk losing that safety net.
The shift in terms of the first rate hike expectation was the highlight of yesterday’s Fed announcement – kind of like the cherry on top of my St. Joseph’s pastry.
The impact for global risk assets begins with my expectation for the yield on the 10-year Treasury returning back toward 3%, with a potential 3.25% target. I also have highlighted in recent market insights and keynote presentations that I am using 2010 (Figure 2) as a possible correlation for the overall S&P 500® Index (Fig 3) in 2014. That would equate to the period beginning in mid to late April as presenting a high probability for the initiation of a multi-month correction that would most likely last through the summer. The 2010 pre-summer high was on April 26. So far, the SPX high for 2014 was on March 7.
Figure 2: SPX 2010, with April 26 Annotated
Figure 3: SPX Prior 52 Weeks, March 19, 2013 to March 19, 2014
As a leading indicator, continue to watch the highly levered speculative carry trade that is short the Japanese yen (Figure 4) and uses the cheap funds to finance purchases of global risk assets. So far, the yen has proven my expectation incorrect and not weakened further in 2014. It still rests above the 200-day moving average at 100.44. The upcoming Japanese consumption tax hike, effective April 15, must be countered with a new round of aggressive easy monetary policy from Bank of Japan Governor Kuroda in order to keep the pro-risk carry trade intact. Over the next 30 days, investors must use the yen as a leading indicator.
Figure 4: Japanese Yen, March 19, 2013 to March 19, 2014