Goldilocks Returns to the Markets


Federal Reserve Chair Janet Yellen broke little new ground at last week’s Federal Open Market Committee meeting, but if you listened closely, she made some news.

The FOMC raised the federal funds rate by 0.25% to between 0.75% and 1%, the third time the FOMC has hiked in the last 15 months. It also continued to insist it would raise rates three times this year. If it follows that script, fed funds would be 1.25-1.5% by the end of 2017.

But in her post-meeting news conference, Yellen expressed growing optimism. ”The simple message is the economy is doing well,” she said in plain English, a refreshing improvement over Fed-speak.

“We’re closing in on our unemployment objective, we’re coming closer to the inflation objective,” she said.

To me that indicates Yellen and the FOMC are turning their focus from employment to inflation, the other side of the Fed’s dual mandate. That implies “gradual” rate increases—at least three a year—for the foreseeable future.

What does that mean for markets?

Well, Goldilocks is back– modest GDP growth and equally modest inflation (both 2% or so). That’s why markets rallied Wednesday after the FOMC meeting, although trading was subdued the rest of the week.

If the Fed can keep raising rates gradually without falling “behind the curve” against inflation (which some conservative economists think it already has), that’s practically ideal for financial markets, all other things being equal.

They aren’t, of course. A lot will depend on how much Congress will pass of President Trump’s tax cuts and stimulus, on which Wall Street has been counting since the election. Regulatory relief already is on its way, as the new administration undoes many of President Obama’s executive orders, which would give corporations much more leeway on issues from labor law to drug approvals to the environment.

Next will come tax reform, particularly cutting corporate taxes and maybe allowing companies to repatriate overseas earnings. That depends, however, on how quickly Congress is able to “repeal and replace” Obamacare, which has proved to be a knotty problem for the Republicans who control both houses.

I think that with some compromises and a lot of arm-twisting by the president, the House of Representatives will eventually pass Speaker Paul Ryan’s legislation. The Senate will be a much tougher slog. That could take precious time from the serious tax cuts for the rich and corporations that Wall Street has bet on since the election. It could be disappointed if tax reform is delayed too much.

Then, of course, there’s North Korea and other potential geopolitical crises. That’s out of everyone’s control, but it shows that in a Goldilocks economy, the Fed matters much less.