So what did we learn from the Fed?
They still think three hikes lie ahead
Investors, though, traded
Like they were persuaded
That four were more likely instead

The first thing to know about the FOMC Minutes is that it is a long, boring document. After all, they are the official record of a government institution’s two-day meeting. And while it may seem that not much gets done, I assure you much get’s said! Looking at yesterday’s release, after an initial modest uptick in both equity and Treasury prices, it seems that investors and traders finally read through to the point (on page 16!) where the FOMC hinted that policy tightening could quicken. The result was a sharp reversal in stock prices, with the major indices falling nearly 2% from their intraday highs, and Treasury yields pushing up to new highs for the move. (Arguably the latter was helped along by the massive amount of paper the Treasury has been auctioning this week, yesterday in the 5-year sector with yields there reaching their highest level since 2009 at 2.658%.

I believe the key paragraph was this one:
“Almost all participants continued to anticipate that inflation would move up to the Committee’s 2 percent objective over the medium term as economic growth remained above trend and the labor market stayed strong; several commented that recent developments had increased their confidence in the outlook for further progress toward the Committee’s 2 percent inflation objective. A couple noted that a step-up in the pace of economic growth could tighten labor market conditions even more than they currently anticipated, posing risks to inflation and financial stability associated with substantially overshooting full employment. [My emphasis] However, some participants saw an appreciable risk that inflation would continue to fall short of the Committee’s objective. These participants saw little solid evidence that the strength of economic activity and the labor market was showing through to significant wage or inflation pressures. They judged that the Committee could afford to be patient in deciding whether to increase the target range for the federal funds rate in order to support further strengthening of the labor market and allow participants to assess whether incoming information on inflation showed that it was solidly on a track toward the Committee’s objective.” FOMC Minutes released 21Feb2018
It is also key to remember that it has been three weeks since they last met and that we have seen a great deal of new information in the interim, notably a payroll report showing AHE rising at 2.9%, and every price gauge printing higher than forecast. It is not hard to understand why the market turned around yesterday afternoon. In short, the idea that the Fed was already leaning toward concern over stronger economic growth leading to inflation moving back to their target and the fact that the recent data was clearly even stronger than expected has investors on alert for a somewhat more aggressive Fed for the rest of this year. Quite frankly, much has been made about the term ‘gradual’ with regard to the pace of rate hikes this year, but if the Fed raises rates once each quarter, that doesn’t seem more than a gradual pace to me.

While there are a number of other Fed speakers on the schedule for the rest of the week, I think all eyes will be turning to next Tuesday morning, when Chairman Powell makes his first appearance before Congress in semi-annual testimony. At this point, it would be surprising if his message was substantially different than what Ms Yellen had been saying, but do not discount a change in style as having an impact. Also, as this is his first meeting, it would not be surprising for the market to react to some throwaway comment he makes in response to a question. If you recall, both Yellen and Bernanke in their first meetings made seemingly innocuous comments that had larger than expected market impacts. In the end, the story remains that the US economy continues to show growth and that price pressures are increasing. I continue to look for interest rates in the US to rise across the curve, and for the dollar to benefit accordingly.

Speaking of the dollar, a look at the overnight session tells us virtually nothing. It was a mixed performance with some currencies showing strength (JPY +0.4%) while others displayed weakness (GBP -0.25%). The most obvious catalyst for movement was in the UK, where GDP growth for Q4 was revised lower to 0.4% and Business Investment in January was actually flat rather than growing the expected 0.5%. Interestingly, Governor Carney was on the tape explaining that the BOE is increasingly concerned over inflation and despite lackluster growth seems more likely to increase rates. In fact, after his comments, the market bid up the probability of a BOE move in May to 85%. And yet the pound could find no solace. As to the yen’s strength, this seems more of a chicken and egg question, given the 1% decline seen in the Nikkei overnight. So did stocks drive the yen or the other way round? Perhaps we saw a bit of a safe haven bid after equity market weakness, but that is not a widespread situation.

However, looking at the dollar over the past week, it has exhibited a solid performance, gaining 1.5% against a broad index and looks like it may have bottomed for now. While the overwhelming majority of pundits continue to look for the dollar to resume its decline, it appears to me as though they are relying on the idea that the market will respond to tighter ECB policy or BOJ policy, but ignore tighter FOMC policy. And of course, that is entirely possible. However, I find it unlikely to be the case, and rather continue to see the dollar as an undervalued asset here. Consider this, with 10-year Treasury yields at 2.95%, which is 2.9% higher than JGB’s and 2.25% higher than Bunds, it is not hard to see the attraction of owning a higher yielding asset in a currency whose central bank is continuing to provide support.

On the data front today we see Initial Claims (exp 230K) and Leading Indicators (0.6%), neither of which is likely to have an impact. We also hear from NY Fed Prez Dudley this morning and Dallas’ Kaplan this afternoon. To me, those will be far more critical to see if there are any clues to how the Fed’s thinking is evolving. Hawkishness has to be creeping into their minds given the recent data releases. Next week’s PCE data will be quite interesting, and after the Powell testimony is likely to be the most important thing we see. But for today, I have a feeling that the dollar will continue to edge higher and both equities and Treasuries will remain under pressure.

Good luck