Fed Hikes Rates: Redline, Dots, Projections, Analysis

Ok, here comes Janet.

Wednesday’s setup was made a bit more interesting by the core CPI miss this morning and by the surprise result of the Alabama special election on Tuesday evening (those two things conspired to put pressure on the dollar which was riding its best win streak of the year going into today). Also, the market just learned there’s a preliminary deal on taxes.

As a reminder, a December hike was baked into the cake (it was ~90% priced in as is always the case in a world where the Fed cannot move without the market’s permission). Here’s the recent history of market pricing going into hikes:

The question(s) then, are how Yellen will describe the outlook in what amounts to her farewell address to the market, whether and to what extent tax reform will be factored into the SEP, what specifically is said about inflation and/or the relentless flattening of the curve and finally, whether there’s any mention of stretched valuations in asset prices (more on all of this below).

Bullet points

Redline

Dots

September:

December:

Projections

September:

December:

Below is everything you should need to parse it all.

************************

This will be Janet Yellen’s last presser as Fed Chair, so whatever you need to do to prepare yourself mentally for that, do it. Here’s what BofAML thinks you should look for as you parse everything:

1. Future path of the hiking cycle: We think Yellen will reiterate the need to proceed with a gradual hiking cycle, even in the face of rising inflation. She will reiterate that most models are still pointing to a low R*, which means a need to be cautious with the speed of rate hikes.
2. Tax reform: We think Yellen will likely be inclined to offer a bit more information about the impact of tax cuts than Powell was in his recent testimony, referencing historical episodes and the literature. She will note that tax cuts should generate a short-term boost to the economy, but will highlight concerns over the crowding out of private investment from deficit expansion. Yellen will also likely caution about adding to the debt given the official CBO estimates of an upward trend, all else equal.
3. Flattening of the yield curve: Yellen will likely be asked about how the Fed thinks about the flattening of the yield curve. She should reiterate that the Fed is not just concerned about the shape of the yield curve, but also the level. Moreover, they are looking at a wide range of financial market indicators and others point to further easing of financial conditions. That said, the yield curve is something that the Fed should keep an eye on to make sure credibility is maintained.