Hawks vs Doves – Fed Exit is closer than you think

hawks_and_doves_-_Google_SearchBy David Nelson, CFA

Evidence continues to mount supporting my view the Fed is moving to an eventual exit quicker than the street believes. Yesterday’s release of July’s FOMC minutes has to be viewed as hawkish. The only debate is to what degree. I stand by my call that the first hikes will come during Q1 2015.

Sign posts pointing to the exit can be found throughout yesterday’s document. The first 3 pages center around a discussion on how to best execute a withdrawal of accommodation. There were a couple of key passages in the release pointing to a consensus that the economy and the labor market are on the path to a sustainable recovery.

This one leaps off the page. “In particular, participants cited strength in airlines, railroads, trucking firms, businesses supplying the motor vehicle and aerospace industries and those in the high-tech sector.” 

Cyclical industries like airlines, railroads and trucking firms don’t do well in an economy that’s about to turn on to I-95 South.

Another key passage. “Contacts in a number of areas indicated that credit was readily available, and reports from participants’ business and financial contacts indicated a strengthening in demand for bank credit.” 

We know the Fed has been targeting unemployment and even here there were signs that the Fed is encouraged by the progress made.

“Participants generally agreed that both the recent improvement in labor market conditions and the cumulative progress over the past year had been greater than anticipated and that labor market conditions had moved noticeably closer to those viewed as normal in the longer run.”

Another even mentioned improvement in the prospects for the long term unemployed. “A couple of participants pointed out that the transition rate from long-duration unemployment to employment had moved up.” 

Admittedly there is a fair amount of miss-direction in the 11 pages giving them the flexibility to adjust course as conditions warrant. Despite the usual rhetoric, this ship is turning. If interest rates rise for the reasons mentioned above then ultimately its good news for the economy and markets.

The Debate Inside the Fed

Last month Dallas Federal Reserve President Richard Fisher wrote a scathing Op Ed in the Wall Street Journal that the Fed had stayed too loose for too long. I actually thought he would dissent in the last meeting. It was Plosser who dissented. This leads me to believe, slowly but surely Fed Governors are morphing into hawks and coming over to Richard’s side of the table.

Not only is the debate raging inside the Fed but outside as well. Stocks and Bonds have both rallied off July lows and for my money something is wrong with this picture. One of these charts is wrong and somewhere down the road either stock or bond investors are going to get caught off sides. Which will it be?

One of these charts is wrong!

S&P 500 1 Year Chart


US 10 Year Treasury Benchmark Yield


The 3 month sector performance chart also speaks loudly. The last 3 months have been driven by Tech, Healthcare and Consumer Discretionary with Consumer Staples and Utilities bringing up the rear. That doesn’t sound like an economy that’s in danger of rolling over. Industrials have lagged but even they are coming on strong.

Sector Performance – 3 Month


Jackson Hole

Every year around this time Fed Heads take a vacation in Jackson Hole. There will be countless speeches and TV interviews with various Fed Governors. The highlight will of course be Fed Chair Janet Yellen’s speech Friday.

I have no doubt she will do her best to keep Fed watchers off balance and make you question everything I have written today. Despite the miss-direction they are telegraphing their exit. It will be slow and normalized rates will likely be much lower than previous cycles but by this time next year we will be talking about how high, not when.