Sunday, June 11, 2017

A Fed preview: What happens in 2018?

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. Past trading of the trading model has shown turnover rates of about 200% per month.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Risk-on*
  • Trading model: Bearish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers will also receive email notices of any changes in my trading portfolio.

Marvin Goodfriend for Fed chair?
Over at Calculated Risk, Bill McBride asked the following questions after featuring analysis from Goldman Sachs which expected a June rate hike:
Almost all analysts expect a rate hike this week, even though inflation has fallen further below the Fed's target. A few key questions are: Does the FOMC see the dip in inflation as transitory? Will the Fed keep tightening if inflation stays below target? Will the next tightening step be another rate hike or balance sheet normalization?
Those are all good questions, but as the market looks ahead to the FOMC meeting next week, it's time to look beyond what the Fed might do at its June meeting, or even the remainder of the year. The bigger question is how the Fed reaction function might change in 2018 as the new Trump nominees to the Board of Governors assume their posts.

Another key question to consider is whether the Trump administration plans to keep Janet Yellen as Fed chair. As there are three open positions on the board, and there are three rumored nominees, any potential new Fed chair would come from the current list of new appointees. Of the three, the most likely candidate is Marvin Goodfriend.

Current market expectations show that December 2017 Fed Funds (black line) to be relatively steady, but December 2018 Fed Funds (red line) have been declining.

Regardless of whether Goodfriend becomes the new Fed chair, I examine this week how the influence of the three likely appointees may change the path of monetary policy in 2018 and beyond.

The full post can be found at our new site here.

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