Janet Yellen seems petrified of scaring the market. We have news for her. At some point she will. It's her job to take away the punchbowl when the party gets started and this house is rocking. The Federal Reserve uptick in interest rates, while widely telegraphed, still managed to surprise markets by it being couched in the most dovish way possible.
How did Janet Yellen do that? The Fed has been consistent in stating that 2% inflation was a target of theirs. In her latest press conference, Yellen made it clear that the 2% target is a target but not a "ceiling". Additionally, her comment that the return to 2% inflation should be "sustained" made it clear to the market that the Fed is okay with letting the economy run a little hot. Janet Yellen may have to talk back the market's reaction this week from her dovish rate hike. The market reacted positively which we expected but we did not expect the extent of that positive reaction.
"surprisingly, financial markets took the meeting as a large dovish surprise-the third-largest at an FOMC meeting since 2000 outside the financial crisis, based on the co-movement of different asset prices." - Goldman's Jan Hatzius 3/15/17
The risk is that the market and economy may overheat. There is also a risk that the Fed could throw cold water on it if Trump's fiscal and tax objectives get bogged down in the swap which we think they already have. The Fed is damned if they do and damned if they don't. It's a guessing game with imperfect information. The kind of decision a trader makes and not the kind that academics make well. The time is ripe for a policy error. Now whether that error takes the market higher or lower depends on the action of the Fed. Right now by portraying this rate hike as dovishly as they did the animal spirits in the market are taking things higher. Next week should tell us a lot more about how the market feels.
The Fed is boxed in. A canary in the coalmine, small-caps keep sagging. The Russell 2000 dipped into negative year-to-date territory on Tuesday morning. There was nary a mention of the debt ceiling that was reached this week. This is going to be a problem and, possibly, with the rancor in DC, it could become THE problem. The Treasury only has about one month's cash on hand. Less than Google (NASDAQ:GOOG) or Apple (NASDAQ:AAPL) have on their books.
Yellen raised rates but couched it so dovishly the market rallied. She is afraid of a negative market reaction. She should be afraid of a positive market reaction as the real reason she raised rates was to cool off the market. Market seems ready to continue its running with the bulls as we suspected. This could be the last 10%. Caution. We are pressing the bets with our more aggressive clients but pulling back for our more risk averse.
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone's financial situation is different. Consult your financial advisor.