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A December Hike And Yellen’s Last Hurrah: Full Week Ahead Preview

A snowy hike and so much more.

Ok, so the tax bill and Bitcoin will be front and center in the week ahead and there’s more than a little irony in that.

Unless the conference committee goes completely off the rails and barring some kind of last minute wave of GOP dissent, things are still on track for getting this done by the end of the year. According to sources, Trump will make his “closing argument” for the tax cuts on Wednesday at a speech in Washington (“God blesh these United Shhates“).

Let’s just be clear on something: this is not aimed at the middle class and everyone knows it. Independent studies show this disproportionately benefits corporations and the wealthy and that’s hardly surprising considering the source. So when you hear Pence pitching this as a “middle-class miracle” just know that he is lying to you, plain and simple:

The Cboe launches Bitcoin futures on Sunday and between that and last Thursday’s insanity, you can bet folks will be preoccupied all week with the crypto space – even more than usual.

Meanwhile, we’ll get a ton on the central bank front, with the Fed taking center stage. A December hike is baked into the cake (it’s ~90% priced in as is always the case in a world where the Fed cannot move without the market’s permission).

Telegraphed

You’re reminded that the dollar is coming off one of its best weeks of the year and is riding a five-session winning streak, the best run since March:

Dollar

This will be Janet Yellen’s last presser as Fed Chair, so whatever you need to do to prepare yourself mentally for that, go ahead and get started. Here’s what BofAML is expecting from her final performance:

  1. Future path of the hiking cycle: We think Yellen will reiterate the need to proceed with a gradual hiking cycle, even in the face of rising inflation. She will reiterate that most models are still pointing to a low R*, which means a need to be cautious with the speed of rate hikes.
  2. Tax reform: We think Yellen will likely be inclined to offer a bit more information about the impact of tax cuts than Powell was in his recent testimony, referencing historical episodes and the literature. She will note that tax cuts should generate a short-term boost to the economy, but will highlight concerns over the crowding out of private investment from deficit expansion. Yellen will also likely caution about adding to the debt given the official CBO estimates of an upward trend, all else equal.
  3. Flattening of the yield curve: Yellen will likely be asked about how the Fed thinks about the flattening of the yield curve. She should reiterate that the Fed is not just concerned about the shape of the yield curve, but also the level. Moreover, they are looking at a wide range of financial market indicators and others point to further easing of financial conditions. That said, the yield curve is something that the Fed should keep an eye on to make sure credibility is maintained.

As far as the projections, there’s probably some scope for the tax cuts to be factored in as the Fed has generally joined market participants in fading the fiscal stimulus push throughout the year. As Goldman notes, the Fed normally incorporates these considerations in real time. To wit:

It is hard to know to what degree the Fed staff and FOMC participants will adjust their projections at this meeting to account for the impact of the tax cuts, but history offers some guidance. In an earlier analysis of the Fed’s response to major changes in fiscal policy, we found that Fed staff updated their fiscal projections in real time, often before bills were even introduced, and had fully accounted for the impact of past changes by the time they became law, as shown in Exhibit 5. FOMC participants updated their own fiscal expectations nearly as quickly, but began to cite fiscal policy changes in the context of appropriate monetary policy a bit later, closer to when the bills became law. This points to at least some accounting for the tax cuts at the December meeting, at least in the economic projections.

Fed1

Here’s BofAML’s take:

The final FOMC meeting of the year will give us a sense of how FOMC officials see the economy evolving as we head into 2018. A key question is whether FOMC officials include the potential impact of tax reform. Moreover, Randy Quarles will be submitting his forecasts for this meeting, replacing Stanley Fischer’s submissions. In our view, the forecasts are likely to be quite similar, but there is a risk Quarles has a more positive outlook for the longer term, buying into the argument fiscal stimulus and de-regulation could boost longer-term growth prospects.

Yes, “fiscal stimulus and de-regulation could boost longer-term growth prospects.” And as a reminder, they could also pole vault us into a high leverage, high vol. regime if they end up accidentally coinciding with a sudden upturn in inflation.

Anyway, for their part, Barclays “expects a slight upward revision for the 2018 growth path” but notes that “the upside risks to growth and inflation from the tax cuts bill … will be incorporated in the official projections only after the final version has been signed by the president.”

Three interrelated things to keep in mind as you think about the December hike and the SEP:

  1. the unresponsiveness of financial conditions

FCI

2. the curve

Curve

3. the shrinking playground

Playground2

Ok, so that’s the Fed. We’ll also get the ECB and the BoE.

As far as Draghi and co. are concerned, they “can afford to be boring”, to quote BofAML. The heavy lifting in terms of forward guidance and the taper announcement was done in October, so they’ll sit on their hands in that regard. The forecasts will be closely watched however. Here’s BofAML:

A number of Governing Council members have hinted at an upward revision in the ECB forecasts in December, drawing on the strong momentum in the data, e.g. with the further improvement in the composite PMI in November. That may hold for GDP, but the inflation scenario will be complex. While it is easy for the central bank to argue that the acceleration in the output gap resorption would warrant an upward revision in core inflation, the staff will also have to take into account yet another deterioration in the base. Last week’s estimate of core inflation for November at 0.9% yoy cannot be ignored. Fortunately for the ECB, its forecasting horizon will be extended to 2020 in the December release. We think that the staff will have inflation in line with the mandate by end 2020, accelerating from 2019’s still borderline 1.7% yoy.

ForecastsECB

Obviously, the BoE will vote unanimously to keep everything unchanged following November’s “dovish” hike. Still, the minutes will get some attention (i.e. if there are still concerns about jumping the gun on tightening) and all of this comes in the context of the ongoing Brexit talks. “Mixed progress on the first phase of Brexit negotiations has led to some Sterling volatility, with trade-weighted Sterling strengthening less than 1% since the November Inflation Report [and] expectations for future rate rises have also been brought forward a little” Goldman notes, adding that “since the BoE’s economic outlook assumes a transitional deal is agreed, progress on Brexit negotiations is unlikely to change the BoE’s guidance that two further rate rises are needed over the next three years to return inflation to target sustainably.”

Meanwhile, don’t forget about Turkey where between surging inflation and jitters about Ankara’s deteriorating relationship with the West, the lira has come under extreme pressure over the past couple of months prompting a series of desperate moves by the central bank to support the currency. Of course that comes amid significant pushback  from Erdogan, the self-described “enemy of interest rates.” This week, they’ll probably raise rates. Generally speaking, it looks like we’ll get a 100bp hike in the late liquidity rate. Simply put: if they don’t deliver, the lira is fucked.

There’s also the Norges Bank and the SNB.

Oh, and finally, we’ll get the special election in Alabama which has the potential to cause all manner of fireworks on the U.S. political scene, so stay tuned for that.

Here’s the full calendar via BofAML

Calendar

 

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