Investors Don’t Believe Fed Guidance Because Of Disappointing Inflation

The Fed’s recent statement and press conference saw the market respond as if they were dovish. That goes against the actions which were a rate hike, a promise of three hikes next year, increasing the balance sheet runoff to $20 billion per month, and increasing the dot plot by one hike in 2020. Overall, those were mostly expected, but it’s still unusual to see investors claim these hawkish actions were dovish. This is a stark contrast to when the market would go crazy over one hike in December 2015 and December 2016. Let’s look at the transcript to see if there’s any dovish statements in it.

The first few changes in the statement are neither dovish nor hawkish. It’s just a matter of the hurricanes being further in the rear view mirror. In the next statement, the Fed probably won’t mention the hurricanes. They hurt job growth in September and helped it October. All else being equal, there won’t be any major long term affects on the labor market because of the storms. Saying inflation is running below the 2% mandate is simply factual. You can argue that is dovish, but I think that would be a stretch. The second paragraph is the same as the first as most of the changes reflect the rebound in activity and hiring after the storm. The third paragraph change shows the labor market is strong instead of strengthening which is also probably because of the storm being further in the past. In conclusion, there’s nothing in this statement that materially changes the Fed’s stance in a dovish or hawkish manner. The changes were all caused by the storm no longer affecting economic metrics. The major changes were the rate hike, who voted for it, and the increased balance sheet unwind. Those were all known from just reading the headlines.

Disappointing Inflation

The reason the market didn’t believe the Fed’s guidance for three rate hikes in 2018 is because inflation decelerated in November. As you can see from the chart below, the core year over year inflation was up 1.7% which is less than the 1.8% inflation in October. Core inflation was up 0.1% month over month. CPI was up 0.4% month over month because of the increases in energy prices. Energy prices were up 3.9% from last month, gasoline was up 7.3%, and food prices per unchanged. CPI was up 2.2% year over year which is 0.2% higher than last month because of the increase in energy prices. As you can see, everyone is more focused on core inflation than the headline number. The slowdown in core inflation was caused by the slowdown in shelter inflation which I’ve discussed previously. Apartments were overbuilt which is putting pressure on rent price growth. Shelter inflation was 0.2% from last month which is the smallest gain since July. Owner’s equivalent rent was up 0.2%. Shelter is one third of the index since it is such a big cost for consumers. Medical care was flat which is down from the 0.3% inflation in October. Apparel prices were down 1.3% which is the biggest decline since 1998.