Now what?

As predicted, yesterday, HERE, I suggested that Yellen would (1) hike 25bps, (2) she would assure markets that no schedule for subsequent hikes exists, but more importantly, (3) she would be less dovish than the market expected.

A range of recent labor market indicators, including ongoing job gains and declining unemployment, shows further improvement and confirms that underutilization of labor resources has diminished appreciably since early this year.

The above sentence is the most important in the statement, my emphasis. Regarding labor market slack, here’s the evolution of the Fed’s view on labor market slack in 2015, statement by statement:

January

On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish.

March

A range of labor market indicators suggests that underutilization of labor resources continues to diminish.

April

A range of labor market indicators suggests that underutilization of labor resources was little changed.

June

On balance, a range of labor market indicators suggests that underutilization of labor resources diminished somewhat.

July

On balance, a range of labor market indicators suggests that underutilization of labor resources has diminished since early this year.

September

On balance, labor market indicators show that underutilization of labor resources has diminished since early this year.

October

The pace of job gains slowed and the unemployment rate held steady. Nonetheless, labor market indicators, on balance, show that underutilization of labor resources has diminished since early this year.

Appreciably tells us the Fed has just accepted that it’s employment mandate has been met. Late, per usual. In reality, the Fed’s employment mandate was reached, long ago. It still has some wiggle room on the price stability front, but not much.

Screen Shot 2015-12-17 at 1.34.27 PM

Core is running at 2% and I don’t buy that Core adequately excludes the entirety of changes in oil prices. Transportation costs filter into goods prices beyond just the standalone transportation line item. Moreover, as I’ve mentioned before, HERE, I believe the market is underestimating the impact of the soon to be realized base-effect of oil declines in CPI calculations.

In short: CPI is a year-over-year calculation. Oil began its halving in Nov/Dec of 2014. Beginning in Q1 2016, CPI will use Jan/Feb/Mar 2015 oil prices to determine inflation rates. download.png As shown above, the pace of oil declines in 2014 (purple dashed line) was infinitely sharper than the pace in 2015 (pink dashed line). As such, when the effects of oil’s 2014 declines are removed, anything above ~$22 will be inflationary vs the prior year trend. While I actually believe $20 something oil is quite possible, such a move would not necessarily be disinflationary vs 2014’s decline. Simply put, in reality, oil prices above $20 should be inflationary, moving forward. With core running at 2% in November, there’s a very real risk that inflation leaps higher, and very quickly so.

So what do you do next? Buy stocks, and buy the dollar. Yes, it’s boring, but it’s what has worked and also what is likely to continue to work. The market is pricing in 3 hikes, the dot plot says 4. The only other real takeaway from the dot plot is the notable decline in 2016 dots, which might reveal a quid-pro-quo for moving slower in 2016 in exchange for the unanimity for initiating liftoff in December.

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