March 16, 2017

Stocks opened a bit lower this morning (Dow -45 pts; SPX -.29%) following yesterday’s rally. Just about everything—except tech, financials and some retailers—is lower in early trading. The market has been very resilient, however, and the Dow has now gone 106 days since experiencing a 1% daily move. Most commodities are higher on the day. But WTI crude is trading down to $48.65/barrel. Bonds are trading slightly lower as yields tick higher. The 5-year Treasury yield is currently 2.02% and the 10-year is trading at 2.52%. By the way, junk bonds are the real story in the bond market this month. After selling off during the last few weeks, they rebounded strongly yesterday in the wake of the Fed announcement (see below).  

The Federal Reserve’s key policy committee decided to raise its short-term interest rate (Fed-funds target rate) by another .25%. This is the third rate hike of this monetary tightening cycle. And Fed Chair Janet Yellen predicted another two rate hikes this year. This was exactly as investors expected. And Ms. Yellen did an excellent job of walking the line between acknowledging acceleration in the economy and yet conveying confidence that growth and inflation won’t derail her plans for a very gradual normalization of rates. She noted that “business investment has firmed somewhat,” the labor force participation rate has stabilized, and while inflation has accelerated over the last year it should continue to rise slowly. The economy should expand at a moderate rate over the next several years. Real GDP is forecast at 2.1% this year and next. “The simple message is, the economy is doing well.” The 5-year Treasury yield dipped in the wake of the announcement to 2.04% from 2.11% and the 10-year yield dipped to 2.50% from 2.58%. That should tell you the bond market was afraid she would predict 3-4 more rate hikes this year. Finally, Ms. Yellen said the “neutral” fed-funds rate is probably “quite low compared to historical standards.” So they won’t need to raise rates as much as in prior monetary tightening cycles.  

Most economists and market strategists believe the Fed’s announcement was masterfully done. And of course, the equity market rally yesterday confirms that. But here’s an alternative view from David Kelly at JP Morgan Asset Management: “This is a party unsupervised.” The Fed is behind the curve in terms of normalizing interest rates. It will take them, he says, two years to fully normalize rates and that is too long.  

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