If something changed on November 8th, the Fed didn’t see it

The portion of the FOMC statement on the economy isn’t that much different than the one released in November. They reaffirmed the continued improvement in the labor market. They did acknowledge the rise in inflation expectations within the TIPS market by saying they “moved up considerably but still are low.” Considering that the 10 yr expectation is at the Fed’s desired 2% I’m not sure why they still think that is low.

They repeated again that they expect “that economic conditions will evolve in a manner that will warrant only gradual increases in the fed funds rate” and that it is “likely to remain, for some time, below levels that are expected to prevail in the longer run.” No belief here in “When the facts change, I change my mind.”

Bottom line, outside of the mention on rising inflation expectations, even though they did their best to downplay it, they did not acknowledge at all the possible influence of incoming fiscal changes and certainly did not mention the sharp rise in long term interest rates. They barely raised their 2017 GDP forecast to 2.1% from 2% and did not change at all their 2018 estimate of 2%. Sure doesn’t seem like they modeled a new tax and fiscal regime. They did not change at all their inflation forecasts.

Exactly as I’ve been thinking about how this plays out next year seems to have happened in response to the statement. Yellen & Co. are saying they will continue to drag their feet in raising short rates. Thus, the bond market is going to do it for them on the long end. The 10 yr yield with 2 minutes ran to 2.49-2.50% from 2.44%. If Yellen wants to avoid getting run over by the bond market, she needs to get a bit tougher with her commentary.

The dots do imply that they will raise 3 times next year but the dot’s are worthless information because the complexion of the committee will be different next year.

Yields are really spiking here with the 2yr yield in particular up by 8 bps to 1.25-1.26%. With the 10 yr yield up by 6 bps, there is some modest flattening as the market latches on to the update dot plot which Yellen said was only driven by a few members. Just a reminder though, in December 2015 when the FOMC first hiked rates, the dot plot had the fed funds rate at 1.375% at the end of 2016 and 2.375% by the end of 2017.

The Fed is woefully behind where they should be with rates because they are latching on to an econometric concept called the ‘neutral rate’ that is best left in the halls of academia. 2017 is the year where this ‘patience’ will catch up to them.

Lastly, while the FOMC statement and the Fed’s economic forecasts did not acknowledge at all the new President, Yellen did say they discussed it but felt it too early to change their assumptions due to the uncertainty of what will get passed. Fair enough.