The Federal Reserve's first meeting of 2018 will conclude Wednesday. It is notable as the last meeting where Janet Yellen will act as Chair. Beyond that though, there probably won't be any major action out of this meeting. However that doesn't mean there won't be any takeaways for traders. Here are some things to look for tomorrow.
Assume Jerome Powell really ran this meeting
It is likely that while Janet Yellen officially presided, that Jay Powell either actually ran this meeting or else he was given deference on how the meeting is run. Yellen is a very collegial leader, and thus I would expect her to make the transition to Powell as easy as possible. Her antipathy toward President Donald Trump doesn't seem to extend to Trump's pick to replace her.
Therefore, we should assume that the press release coming out of this meeting is consistent with what Powell would want to communicate if he were the full Chair.
What does the Fed think about inflation?
By far the biggest debate within the Fed is how inflation will react to an accelerating economy. There hasn't been much in terms of new hard data between the last Fed meeting and now to "resolve" the debate. Core PCE, the Fed's favored inflation measure, came in at +1.5% during calendar 2017, which is in line with November's estimate. Core CPI ticked up by 0.1% to 1.8% for the year. But all in all, it's basically the same picture the Fed was looking at when they met in December.
That being said, the Fed hasn't been hiking because they are afraid of today's inflation figures. They are hiking because they are worried that economic strength generally and unemployment specifically are likely to cause inflation down the road. If they don't act now they will fall behind the curve.
With that in mind, and remembering that everything they change in the release was done for a reason, look for how they characterize economic growth. If they upgrade it, they are considering hiking at a faster pace than previously communicated. However if they moderate it, e.g., talking about patience or needing more data or nascent signs, etc., that probably means they want to hold to 3 hikes in 2018 for now.
Rates have risen recently, does this matter?
Interest rates have been creeping up lately, getting much attention from the media. Perhaps more importantly, the stock market seems to have taken notice the last couple days, selling off pretty hard. Could the fact that rates have risen a bit give the Fed pause? And might this get mention in the press release?
I actually think the opposite is much more likely. The Fed is very unlikely to react to the stock market selloff over the last two days. They are much more likely to react to the 6.2% increase in the S&P 500 since they last met, just six weeks ago. As far as rates rising, I doubt this worries them at all. If the economy is getting stronger, they want to see rates rising. This will feel very normal and healthy to them.
The dollar is one wildcard
The only reason why rising rates might (indirectly) get the Fed's attention is the fact that the dollar is falling. All else being equal, a falling dollar creates some inflation pressure, which in turn would make them more likely to favor hikes. In this case, I think the dollar is mainly being influenced by recovering growth in Europe and Japan, which the Fed will view as a positive development. In the release, they might mention the dollar specifically, but pay more attention to whether they mention global growth. If they do, that's a hawkish sign.
Right now I'm still long bonds paired with a flattener. This means I'm net long (betting rates will fall) but expressing that by being short 3-7 year bonds and long 10+ year bonds. Obviously the last few days this trade hasn't worked, but I have a more intermediate-term view, so I'm still comfortable with the trade.
If indeed the Fed comes out more hawkish at tomorrow's meeting, given the momentum, I'd bet the knee-jerk reaction will be for both bonds and stocks to sell off. However I'd be completely happy to get long either on that reaction. The bull market in stocks won't end because the Fed is hiking. It will end because economic momentum stalls. Of course, that could happen because the Fed hikes too far, but I'm confident we have a ways to go before we get there.
As far as bonds go, the technicals are now pretty bad for my long position. It's gappy between here at 3%, which definitely creates some risk that I suffer for a while even if I'm eventually right. The good news is that a net long position in bonds generates income, so you get paid while you wait for the trade to work out. But more fundamentally, I don't see any logical way a hawkish Fed today turns into a steeper yield curve. So either my long position works or my flattener position works or both.
This column originally appeared on Jan. 30 on Real Money Pro, our premium site for active traders and Wall Street professionals. Click here to get great columns like this even earlier.