The key takeaways from the FOMC statement on Wednesday were that rates weren’t raised, the Fed plans to unwind the balance sheet starting in September, and the Fed downgraded its inflation comments as it slowly acknowledges that inflation hasn’t been as strong as it had been claiming it was earlier in the year. It’s interesting to see that CNBC decided to call the Fed’s asset purchases ‘stimulus.’ It’s weird to call it a stimulus which took the economy out of a recession when it continued until 2014. In what world is stimulus used 6 years into a recovery? The Fed has changed its definition of what QE was to fit whatever narrative it’s promoting. The Fed has said in the past that QE wasn’t effecting the economy. As you can see from the quote below, the Fed has said there’s no link between QE and inflation and real economic growth. That’s not a stimulus.

I will now go through the changes in the language of the statement and then I’ll review the statement’s effect on the markets. The first change was eliminating the claim that job gains have moderated. That is because July’s BLS report showed 222,000 jobs created. That increase was helped by the local government hiring excess workers, but it was still a good report. The March report showed 50,000 jobs created and the May report showed 152,000 in job growth which is why the moderate moniker was in the previous statement. The Fed also eliminated the fact that household spending had picked up in recent months. This concludes that consumer spending has been consistent. The Fed is clearly ignoring the tick up in consumer credit defaults. To be clear, I’m not saying it should mention that. I can mention every change in prices, but the Fed can’t do so because these reactions will look like policy changes.

That’s why the Fed has missed the disinflation. It didn’t want to mention it in case it was a temporary change. Also saying inflation is declining messes with the guidance for rates to be raised 3 times this year. That’s why the Fed chose to ignore the data for a few months; that has changed in recent statements. In this statement, the Fed got rid of the word “recently” to describe the declines in inflation. That’s a dovish statement which acknowledges the declines have continued. It’s now a trend opposed to a transitory change. The Fed also removed the word “somewhat” in regards to inflation being below 2%. This new language is more bearish on inflation, once again making the dovish point that inflation has fallen.

Moving to the 5th paragraph, the Fed added the words “for the time being” when describing the balance sheet reduction which is also referred to as halting the reinvestment into treasuries and mortgage bonds. This has been interpreted as pointing out that the unwind will start sooner than later. In my article previewing this statement, I said that the unwind would start in September, so this is simply a confirmation of what we knew. The Fed the added the words “relatively soon” which further heightens the point that the balance sheet reduction will occur in September. The program will only start at $10 billion per month which is why I don’t think the Fed will delay it because of the debt ceiling stress. This could cause the market to selloff, but the Fed can’t set the precedent that every minor fiscal policy change will cause it to stop the unwind. In the few months after the debt ceiling is raised, tax cuts will be debated. Arguably, that will affect the markets more; the Fed wouldn’t want to change policy based on volatility surrounding that debate either.

The final change in the statement was that Neel Kashkari voted to keep rates stable, meaning the Fed was unanimous in this decision. That’s not surprising because Neel is one of the most dovish members. He will likely dissent in the next meeting where rates are increased and he will likely agree with rates remaining stable in the September meeting. There is now a 100% chance the Fed won’t raise rates in September. That’s down from the 92.2% chance of a rate hike in September yesterday which means this was a relatively dovish meeting.

If you look at the indexes, the biggest move occurred in the Russell 2000 which saw a decline of 0.56% on the day. The dollar sold off 0.75% which goes along with the theme of international firms outperforming domestic firms because of a weakening dollar. The statement being construed as dovish added to that theme. Some say that the Fed unwinding the balance sheet means the dollar will rally, but I disagree. If the ECB ends its bond buying next year, that will be a 60 billion euro per month difference. That’s a bigger deal than the peak of the Fed’s unwind which is $50 billion.

There was a sharp rally in bonds, but that didn’t reverse the selloff which has occurred this month. The 10 year is now at 2.2872% and the 2 year is now at 1.3551%. The difference is now 93.21 basis points as the yield curve has steepened outside of the T-bill market. That makes sense as the economy will likely see an annualized Q2 GDP which is growing at above 2%. There’s no sign of a recession occurring in 2017.

Conclusion

Facebook beat earnings expectations and rallied 4% after hours. This along with the dovish Fed are great means of support to prevent a 5% correction until after the summer is over. The 271-day streak without a 5% fall will likely reach 300 days. The later in the year we get, the closer we get to the global tapering which might catalyze multiple contraction. I think the bull market will end in 2018 if tax cuts aren’t passed. The way the GOP deals with the debt ceiling in September and October will give us information to make a guess about how tax policy will play out.