U.S. Economy Slowed, Fed Doesn't Care. Market Risk Into Wednesday

Fed Vice Chairman Stanley Fischer admitted last Friday on CNBC that the economy has slowed:

“We’ve had weak first quarters for the last three years and now possibly it will be four. There is something going on that we don’t understand in the data.”

But when he was asked about the Fed’s rate hike schedule this year he said:

“So far haven’t seen anything to change that.”

So you have slowing growth but no change to the Fed’s hike schedule. His interview Friday gives us a key hint regarding what the message will be this coming Wednesday.

The Fed likely maintains the wording of its earlier statement, “gradual increases in the Federal Funds rate” despite the economic slowdown. We don’t expect a rate hike next week. We do expect one in June.

Add two more “hawkish” (wanting to raise rates) points to next Wednesday.

1. They are not only raising rates they will be ending asset purchases in the near future.
2. The Fed had not officially incorporated President Donald Trump’s fiscal policies into their overall rate targets because they hadn’t officially seen those plans.

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Now, after yesterday’s press conference where Treasury Secretary Steven Mnuchin and chief economic advisor to the president Gary Cohn laid out those plans, the Fed has finally seen them.

Here’s what Fed Chair Yellen said at the last Fed meeting in March :

“I think it’s fair to say, there’s nothing that’s a speculation about preemptive responses to future policy moves. We have plenty of time to see what happens.”

That’s Fed-speak conveying that the Fed’s three, planned rate hikes for 2017 do not incorporate much fiscal policy. However, after yesterday’s press conference the Fed can be less speculative and can now include some fiscal plans. That would bias their rate targets higher.

So along with Fed Vice Chair Stanley Fischer’s ignoring the slowdown, you have less speculation on fiscal policy and no change to the path of at least three rate hikes this year.

In fact, the Fed’s Eric Rosengren said there should be four rate hikes this year.

The real issue is the Fed is behind their own curve. With inflation at 2% the Fed says the neutral real rate they want to get back to is 1%. They need to get back to 2% inflation + 1% real rates or a 3% Fed Funds rate.

They are currently below 1%. They are still moving ahead with their configuration of eight more 25bp rate hikes, just to get back to their version of “neutral.” And the economic slowdown isn’t stopping them.

Why are they not slowing down the pace of rate hikes even with the weak economy? Because equity markets are letting them.

Here’s what Fed Vice Chair Fischer said on April 19th :

“The reaction in financial markets to the FOMC's decisions… seems benign.”

The Fed is behind their own curve. They are still moving ahead with what amounts to eight more 25bp rate hikes just to get to neutral, despite the economy slowing because…“financial markets” are “benign.”

Even though higher rates may hurt the economy further as it slows, “financial markets” are allowing the Fed to keep raising interest rates.

Can this break at some point? If growth doesn’t pick back up, yes this can certainly break the markets lower.

In the meantime, the Fed is saying the markets are leading their decision process despite the economy. That’s a risky setup because at some point the market will decide not to give them a pass if the economy continues to slow.

At that point the Fed’s window will have closed. And raising rates despite the slowdown will have been a bad idea. Until then, the Fed is full steam ahead. Be careful into next Wednesday.

Disclaimer: ETFs reported by Elazar Advisors, LLC are guided by our daily, weekly and monthly methodologies. We have a daily overlay which changes more frequently which is reported to our premium members and could differ from the above report.

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Written By: Investing.com