Although nobody in the game expected Janet Yellen to make any moves regarding rates yesterday and the changes to the Fed's post-announcement statement required a microscope to identify, this week's meeting of the FOMC was important nonetheless.

After spending nine years pulling rabbits out their hats in order to keep the economy out of the deflationary ditch, you can bet your bottom dollar that Yellen's merry band of central bankers would like to return interest rates back to more normal levels. And in case you've been living in a cave for the last couple years, you know that the Fed has begun the process known as "policy normalization."

The problem is that in each of the last two years, Yellen & Co. have been forced to put the brakes on their plans due to what the WSJ called "economic shocks, especially from abroad." As such, the Yellen has only managed to push out two rate hikes of 0.25% each so far.

While Fed members appear to be bent on raising rates at least three times in 2017, the markets are less than convinced at this stage. For example, according to Ned Davis Research, the Fed Funds Futures are projecting just 1.5 additional rate hikes in 2017. The issue at hand appears to be the lack of strength in the "hard" economic data. And Exhibit A in the argument is that the Fed may have to once again shelve their normalization plans, was the underwhelming Q1 GDP report (which sported a rather anemic annualized growth rate of just 0.7%).

Showing Some Resolve

However, at least at this stage of the game, Yellen's gang appears undeterred as yesterday's postmeeting statement remained surprisingly upbeat. In fact, the FOMC statement suggested that the weakness seen in the January-to-March period was "likely to be transitory."

Perhaps this is due to the plethora of strong "soft" economic reports seen so far this year. Perhaps Yellen is standing behind the inflation data, which has reached the Fed's target zone. Or perhaps the Fed is looking to boost its reputation by sticking to its guns here. But the bottom line is that yesterday's statement signaled that Janet Yellen is assuming a "steady as she goes" stance with regard to the path of monetary policy.

Reasons To Stay the Course

First up on our list of reasons why Janet Yellen is likely to stay the course for three rates hikes in 2017 AND the start of a campaign to reduce the size of the Fed's balance sheet by the end of the year is the fact that wage pressures are building.

Most folks think that commodities such as oil and grains are the primary drivers of inflation. But in reality, my work shows that wages are the key driver of CPI. And don't look now fans, but wage pressures are starting to increase.

For example, the Atlanta Fed's Wage Growth Tracker moved up smartly in 2016. And then after a drop into the election (likely due to uncertainty over the outcome of the vote) the wage growth tracker is now moving higher again. This has helped push the Employment Cost Index up 2.4% on a year-over-year comparison basis, which is near the upper end of the recent range, as well as the trends of other compensation surveys.

Next up is inflation. The bottom line here is the PCE (the Fed's preferred inflation measure), which looks to have stabalized around the FOMC's annualized target of 2%.

Then there is the fact that the stock market is near all-time highs. The first point here is the Fed has publicly voiced its concern about valuations in the stock market. So, if the market were to freak out over higher rates, Yellen has cover to say, "I told you so." In addition, although the FOMC has been talking about raising rates AND starting to reduce their over $4 Trillion holdings, the stock market is none the worse for wear. Thus, the Fed appears to have a green light to proceed from the stock market.

Finally, and while I will admit this is pretty geeky stuff, the "real Fed Funds rate" (which adjusts for inflation), is currently LOWER than it was when the Fed started raising rates. Therefore, one can argue that the Fed is currently "more accommodative" that it was when the Fed Funds rates was back at 0%.

The Takeaway

So, while the "hard" economic data has been soft and Yellen's bunch has backed off plans to raise rates due to economic softness in each of the last two years, for now at least, it appears that the Fed has backing to stay the course in terms of normalizing monetary policy. And from my perch, this is a good thing from a big-picture perspective.

Thought For The Day:

Learn to trust in an idea whose time has come...

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

1. The State of Trump Administration Policies
2. The State of the U.S. Economy
3. The State of Earning Season
4. The State of World Politics

Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

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