The coming week is chock-full of important, potential market moving events.
The ECB finally implements the first round of the previously announced LTRO program. We get Bank of England and Federal Reserve meetings on Wednesday. Then on Thursday, the Swiss National Bank meets. Friday is Quadruple Witching. On the week-end there is a G20 meeting. And oh yeah, Scotland votes on whether to leave the United Kingdom.
Although there is shortage of things to talk about, many market pundits seem to be fixated on whether the Federal Reserve is going to change their “considerable time” language. There is a fair amount of worry that the Federal Reserve is going to move up the timing of the first rate hikes.
A growing crowd of market watchers thinks that the Fed is behind the curve.
The market has suddenly become worried that the Fed is going to try to guide short term rates higher.
Although I think that the Fed should get out in front of the curve, there has been little evidence to support that this is what the Fed will do. In fact, everything the Fed has done and said since Yellen’s appointment as the head of the Federal Reserve has indicated that the Fed is going to be extremely slow to raise rates. Just because recently a couple Fed hawks have squawked about the rising risks does not mean that the Fed is going to suddenly becoming tight. These hawks have been worried about the risks the whole way along.
I have repeatedly stressed that the Fed is going to reluctantly raise rates. The curve will eventually be extremely steep due to their unwillingness to raise short term rates.
Right now the market is trading based on previous market cycle playbooks. In the past as the economy has improved, the Fed has tightened policy fairly consistently. But that was before the Fed was stuffed to the gills with bonds and the world was mired in a balance sheet recession.
This time the Fed will be loath to stall the economic recovery. Yellen has repeatedly emphasized this fact. The playbook has changed.
Let me repeat that again – the Fed will be extremely slow to raise rates.
Given the current amount of uncertainty in the rest of the world, I think it is especially improbable that the Fed uses this meeting to readjust market hiking expectations. With the Scottish referendum looming on Friday, combined with the abysmal European economy and topped off with all the geopolitical problems, there is little need for the Fed to run out ahead of the curve.
And don’t forget last month’s terrible US employment report. With such a big miss it is unlikely that the Fed will use the very next meeting to get hawkish.
The market is over estimating the Fed’s willingness to guide short term rates higher at this meeting. The Fed will attempt to give themselves more flexibility, but by no means do they want short term rate hike expectations brought forward. My guess is that they are happy with their current guidance and they will just try to cement that timetable.
In the meantime though, the market is fretting. The US dollar continues to rally and there are increasing signs of stress starting to pop up. Have a look at the trading of the REIT index on Friday.
That is an ugly day.
I don’t think the Fed is going to be unhappy with this sort of “risk off” trading. Don’t forget that they are worried about financial excesses eventually causing another credit crisis.
My suspicion is that they are pleased with the fact that the stock market and other risk assets are going down on their own, leaving the Fed the ability to have short term rates stay low for a little while longer.
Also the recent rout in the commodity markets relieves the Fed of much of the worries about their dovishness translating into inflation.
Given my belief that the Fed will err on disappointing the bears at this Wednesday’s FOMC meeting, I am tempted to cover a little of my short stock market position. But the one thing I have learned is that when the selling finally starts, it often keeps going on longer than I would have guessed.
From a technical point of view many stock indexes are starting to break down. The bulls are only now starting to think about selling.
Even with a dovish Fed meeting, I think there is a decent chance that this selling will continue.
I am still trying to come up with a game plan for this Fed meeting, but I am thinking that maybe something like a long precious metals might be a better move.
I am going to buy a little gold and silver this morning. It will be a small starter position as the precious metals are definitely in a bear market. Maybe I will regret not buying back my stock short instead, but I do want to be long something if the Fed does indeed err on the side of dovishness.
It is a fine line
It is a fine line that the Fed is trying to walk.
The WSJ’s Jon Hilsenrath recently did a great job outlining the problem.
Here is the challenge they face as they prepare for their policy meeting next week: investors tend to see the world in black and white. They might look at the removal of the “considerable time” language as a sign that interest rate increases are imminent, like a starter’s gun going off before a race. In January 2004 the Fed removed an assurance that rates would remain low for a “considerable period” and started hiking by June. That’s not a signal they want to send just yet. This time, Fed officials want to move away from these commitments, but they want more evidence on the economy’s performance before they decide when to raise rates. After months of surprisingly strong job reports, the latest data went limp in August.
Can Fed officials craft a message that frees them from the commitment without appearing to the market to be binding themselves to the beginning of a new rate hike cycle? They could change considerable time and leave other low-rate cues in their statement – such as the judgment that there remains significant slack in labor markets. Moreover, Chairwoman Janet Yellen has a tool that Alan Greenspan didn’t have in 2004 – a press conference to explain the central bank’s views. It’s a venue she has tended to use effectively during her first six months as Fed chairwoman, clarifying rather than confounding. <br .>It’s not clear that officials will dump the low rate assurance this time around. In an interview with The Wall Street Journal last week, Boston Fed president Eric Rosengren suggested that October might be a better time to change. That’s when the bond-buying program referenced in the interest rate guidance ends. They could even feasibly wait until December to change the “considerable time” language and simply lop off for now the reference to the bond program in the forward guidance. But it is clearly at the center of discussions as officials prepare for next week’s meeting, and on the table for a shift.
Repeat after me: “QE programs are bond bearish.”
The idea that QE programs are bond bullish continues to propagate through the media. I have read article after article talking about the perplexing trading in the European debt markets since the announcement of Draghi’s expansion of asset purchases.
Although the global bond markets top ticked almost to the day of Draghi’s announcement, the sell off in bonds has been attributed to the Fed’s policy tightening. The Fed has basically not changed their guidance one iota in the last month. Yet the whole world is blaming their supposed tightening of guidance for the global bond market sell off.
Have a look at this article from Bloomberg titled Global Bonds Post Biggest Decline Since 2013 on Fed View
Global government bonds posted the biggest two-week drop in 14 months on concern the Federal Reserve will alter the language of next week’s policy statement to indicate officials are closer to lifting interest rates.
Are there actually any signs that the Fed has changed their stance? Nope – not one. So what has changed? Well maybe it has something to do with Draghi’s commitment to expanding the ECB’s balance sheet.
Don’t believe me? Then listen to what is probably the smartest hedge fund manager out there right now had to say.
Tepper: ECB decision means “beginning of the end” of bond market bubble
If the Fed does err on dovishness at this Wednesday’s meeting, then I am going to use any bond market strength to sell into…