We feel the Fed has embarked on a middle path on the policy speech. While the policymakers seem upbeat on the 2018 GDP growth prospects, they are still worried over on the current low inflation and remain unclear on the tax changes’ impact on labour supply as well as corporate windfalls though the tax cut should boost consumer spending.

Besides, we noticed some form of discomfort on the current market valuations which are supported by the overly accommodative policy that can inflate bubbles, and over time poses risks to financial stability. While they were largely dismissive on concerns over the yield curve, where an inverted curve with short-term rates is higher than longer-term rates often signals a recession, as they felt other factors were likely at play that are less ominous, still it is important to continue monitoring the slope of the yield curve.

In our view, the inflation shortfall will be the centre of attention for the new Fed Chair Jerome Powell during his first few months of tenure. If inflation picks up, we expect rate hikes will be faster, reaching our 3-rate hike scenario for 2018. But if inflation continues to struggle, we are looking at 1 or 2 rate hikes at best.

• We feel the Fed has embarked on a middle path on the policy speech. While it expects reductions in corporate and personal taxes to boost consumer and business spending, it remains unsure of the impact of the new tax law, according to minutes of December’s Federal Open Market Committee (FOMC) meeting.

• The discussion focused on strong observations on the economy, highlighting significant improvements in payrolls as the unemployment rate dipped to 4.1% and industrial production improved quickly. The policymakers observed that the S&P 500 rose about 20% partly due to the anticipation of the Republican tax overhaul, slashing the corporate tax rate from 35% to 21% and lower income tax brackets for most payers. Hence, they raised 2018 GDP from 2.1% t0 2.5% which falls in line with our forecast.

• While citing that the real economic activity is growing at a solid pace supported by strong consumer and business spending, supportive financial conditions and an improving global economy, they still seem unsure over just how much a boost in activity would come from the tax plan. It remains unclear on how the tax plan will impact labour supply and whether the windfall corporations would get from tax cuts would be spent on dividends and share buybacks.

• Besides, we noticed some loggerheads on the inflation setting in which the Fed has consistently missed its 2% inflation target. There was concern that inflation might stay below the target for longer than they currently expected. Inflation is likely to meet the 2% target over the medium term

• In the meantime, the committee members were largely dismissive on concerns over the yield curve, or the difference in bond yields across various maturities. While an inverted curve — when short-term rates are higher than longer-term rates — often signals a recession, they felt other factors were likely at play that are less ominous. Still it is important to continue to monitor the slope of the yield curve.

• There again were some concerns about market valuations. While rising stock market indexes generally look favourable, the concern is that keeping policy overly accommodative could inflate bubbles. It can over time pose risks to financial stability.

• We felt the Fed has embarked on a middle path. In our view, the inflation shortfall will be the centre of attention for the new Fed Chair Jerome Powell during the first few months as the Fed Chair. If inflation picks up, we can expect rate hikes to be faster, reaching our 3-rate hike scenario for 2018. But if inflation continues to struggle, the Fed could end up with 1 or 2 rate hikes at best.

Source: AmInvest Research - 5 Jan 2018