The Federal Reserve could rival the White House as a source of volatility in the week ahead.
Since he was elected, President Donald Trump has taken the driver’s seat for markets, pushing the obsessive focus on the Fed aside, with his promises of big pro-growth fiscal policies impacting market expectations.
But the current back seat driver could grab the wheel for at least two days in the coming week, when Fed Chair Janet Yellen testifies before Senate and House committees on the economy and Fed policy.
“Certainly investors are paying close attention and given the fact the VIX is … at some crazy low number, it’s possible we see a volatility pop,” said Jack Ablin, CIO of BMO Private Bank. The VIX, the CBOE’s volatility index, was at a low reading of 10 on Friday, indicating to some a high level of market complacency, as stocks leap to record highs.
“Just like last year, they [the Fed] started the year with a forecast where were going to have four rate hikes, and we got one. I think the same thing this year. Her rhetoric could be construed as hawkish but with very little action,” said Ablin.
On Wall Street, traders are waiting to hear if Yellen signals that the Fed is on track to raise interest rates three times this year, as it forecasts, and the timing of when it might next move. Analysts also expect to hear pointed questions aimed at the Fed’s own policies and what Yellen thinks about potential new tax policy, fiscal stimulus, banking deregulation and efforts to exert new supervision over the Fed itself.
Ablin expects Yellen to be circumspect, given the scrutiny of the Fed and unknowns about the shape and timing of Washington policy. “I actually think Trump and Yellen are on the same page. I think they want the same thing. ‘Let the economy run hot and drag your feet raising rates.’ I don’t see a lot of controversy. The controversy could be around the independence of the Fed and [Sen.] Rand Paul wanting to audit the Fed,” he said.
There are also a few important economic reports in the week ahead, with CPI inflation data and retail sales Wednesday. There are some major earnings including PepsiCo, Cisco, Kraft Heinz and AIG.
Trump, of course, will stay a top focus, as he has since before his first day in office. In the past week, he shook markets out of their doldrums by promising Thursday he would provide details on tax reform in the next two to three weeks. That launched a stock market rally that took major indexes to record highs, put a bid under the dollar and drove bond yields higher. It also turned the market focus back to the programs that helped propel stocks higher since the election — not the recent controversies around immigration, trade and his daughter’s clothing line.
“I think we’ll just wait for the tax stuff to come out and we’ll wait for other stuff. I still think the market could go up in the meantime. I think the equity market is now the new Nielsen ratings for Trump,” said Ablin. “That’s his barometer … between tweets and remarks.”
Trump meets with Canada’s Prime Minister Justin Trudeau on Monday, after spending the weekend with Japan’s Prime Minister Shinzo Abe. In the past week, Trump also made conciliatory comments to China’s President Xi Jinping about the country’s One China Policy regarding Taiwan. That reduced some market concern that Trump will steer the U.S. into a trade war with China.
Key stock indexes in the past week all closed at record highs. The Dow gained 1 percent for the week, ending at 20,269. The S&P 500 was up 0.8 percent at 2,316, and the Nasdaq was at 5,734, up 1.2 percent for the week. The 10-year Treasury yield was fairly active during the week, at 2.40 percent Friday after touching a low of around 2.32 percent Wednesday.
Gold futures for April, rallying most of the week, sold off in the final two U.S. sessions but ended up 1.2 percent at $1,235.90 per ounce. Oil bottomed hard mid-week on worries of oversupply but bounced back to end the week flat, with West Texas Intermediate futures for March at $53.86 per barrel.
As for the Fed, the markets have been at odds with the Fed’s forecast and its own expectations. Wall Street is skeptical the Fed can hike three times this year, and targets more like two rate hikes.
“[Yellen’s] always a market moving event, but I feel like basically there’s no upside, there’s no reason for her to come out and use this as an opportunity to launch the Fed’s pace, or trajectory for the Fed’s balance sheet. It’s too early,” said George Goncalves, head of rates strategy at Nomura.
Fed officials, since their last meeting, have been talking about the day when they will stop holding onto the $4.5 trillion in Treasury and mortgage securities in their portfolio, and allow them to roll down. The Fed now replaces them, and if it were to cut back that would be the first step in the Fed reducing its balance sheet. It is not seen as something the Fed would do until possibly next year, but it has gotten the market’s attention since the Fed signaled it was discussing it several months ago.
There also has been a debate within the bond market over whether the Fed could signal that it could raise rates at its March meeting, seen as unlikely by most Fed watchers. Expectations for March were further dampened when the Fed gave no indication in its Feb. 1 statement that it was ready to move, and the weak wage growth in the January jobs report lessened expectations for inflation — and Fed rate hikes.
Goncalves said Yellen would not want to be boxed in by pointing to any time frame for a hike, thought the markets expect a June move. “If the outlook is so rosy and so robust and they’re feeling they are behind the curve, they could ramp up three hikes in the second half of the year. March is not going to be an insurance hike to start the process for 2017. You just don’t do that to get the ball rolling. You do it when you have more confidence in the outlook … It’s all about confidence. Not confidence around [Trump], just confidence about what’s going to be delivered on the government side,” he said.
The Trump tax plan will also remain top of mind for markets, and there now is a wait-and-see on what he will propose — a similar plan to the House Republicans, which includes a border adjustment tax, or something else.
The controversial border-adjustment tax would be a key way to pay for the corporate tax cut, which under Speaker Paul Ryan’s plan would take the corporate rate to 20 percent from 35 percent. It basically taxes imports at a 20 percent rate but there would be no tax on exports.
“There’s just uneasiness in the senate over this. This is going to be a roller coaster ride,” said Daniel Clifton, head of policy research at Strategas. The House plan proposes a one-time repatriation of the $2 trillion in corporate cash stashed overseas, full expensing of capital equipment and a limit on deductability of interest. But without the border adjusted tax, or destination tax, the plan would not carry a tax rate as low as 20 percent. Many S&P companies already have tax rates in the low 20s percent.
Congress is lining up on both sides of the border-adjustment tax, and so are companies, with industrial companies like GE and Caterpillar in favor of it and retailers, like Target and Wal-Mart against it.
“It’s like ‘Hunger Games’ for tax lobbyists now,” said Clifton. “If you’re negatively impacted by the border tax, you’re pushing the net interest deductibility.” Limiting interest deductibility would be a negative for financial firms.
Clifton said the market may not get what it’s looking for in Trump’s tax plan. “This is: They promise something big, but it’s not meaty,” Clifton said.