Beware the FED

Outlook:

We get housing star ts, industrial production and CPI this morning before the Fed statement at 2 pm ET and the press conference at 2:30 pm. CPI is the important one. The most recent release indicates core CPI up 1.7%. The PCE price index is up 1.3%. On Monday, the NY Fed released a survey from Feb showing consumers expect inflation to rise 2.7% over the next year, up from 2.4% in Jan. This is a critical finding because the Fed cares as much about inflation expectations as about the inflation reading itself.

Next comes the dot plot showing where members think hikes might come. The December reading of four hikes this year was widely scorned and dismissed and cut to three right away by market observers. This time it may come down to two, according to a survey by the WSJ. Fed funds futures indicate only one more hike this year. June is now the favorite date for the next one.

The third big factor is “global turmoil,” the catchphrase for everything from negative rates in Japan and Europe to slowing growth and stock market crashes in China (not to mention the refugee crisis, Brexit, and a handful of other disruptive factors). Every once in a while you hear some Grand Poohbah on TV preaching that the US should not be bucking the global trend toward recession and by raising rates, contributing to it.

The most pressing question is how confident the Fed sounds on any of these matters—inflation expectations, the pace of hikes and the state of the global environment. Divergent views from various regional Feds have been a problem. More than one wag has said we probably have to wait for June in order for Yellen to get a unanimous vote, since dissents are worrisome to the bond boys. We say it would be wonderful to get a clear statement (for once) and maybe a hard clue about timing with an explicit brush-off to any concern about lack of unanimity. This would show “leadership” and that’s what everyone is seeking these days.

On inflation expectations, the FT dusted off its wonderful chart showing the correlation of the TIPS spread vs. the price of oil. Here it is again.

As long as the Saudi-inspired proposed output freeze remains on the table, we can have some hope that oil will not plunge back to the $30 level. It doesn’t have to soar to $60 or $80 to influence inflation expectations, just demonstrate that the bottom is in. The announcement effect of the freeze conference on April 17 in Doha was a swift $1 rise in the price of oil. We might be starting to see supply constraints overcome worries about the supply glut and faltering demand. Perhaps $60 is not a silly number. After all, oil traders are famously able to ignore what’s in front of them and to focus on some far-distant thing instead.

We have complained many times that the Fed continues to view the price of oil as always temporary and aberrant, and certainly not something it can manage or control, so let’s ignore it altogether. This is not a smart stance for people who are supposed to be bright. Maybe the Fed has a secret economist or two who have a clear ides of whether the bottom really is in. If the Fed believes the oil bottom is in, the Fed’s idea of inflation expectations is a one-way street. If the Fed is brave today, this could be the reason.

It may be wishful thinking, but we imagine the Fed is getting tired of lack of confidence in its work. The Fed says four hikes and the market sneers and prices in only one. This is a blow to “reputation risk.” We would like to see a more aggressive Fed today, even if the number of rate hike dots gets reduced.

And if the dots do not get reduced, the market will be shocked. Depending on how good the explanation is, yields could bounce. The 2-year is steady at 0.96% this morning—it could rise back to the Jan high of 1.0713% and presumably more. See the Bloomberg chart. And the dollar would spike on the news. The spike might not last but it would be a big fat warning to the gloomy Gusses in the bond market. Even a cut from 4 to 2 hikes, if well-defended, can be dollar-positive. It’s one more than the market sees now.

Political Tidbit: One more Republican candidate has bit the dust—Rubio, with zero executive experience, had to withdraw after losing his home state. The newspaper and talking heads on TV have plenty of reasons for his failures, but we say only one counts—talking about Trumps’ small hands. Americans are a strange mix of prudery and appreciation of the garish and vulgar. In the end, prudery wins. Voters may turn out for the Trump show, but that doesn’t mean they will vote for him. He is, after all, a train wreck.