With 2 weeks left in Q3 2015 and less than 2 days before a highly anticipated FOMC interest rate decision, investors and traders seem evenly divided over what the FED SHOULD do, as well as what the FED WILL do, and whether the next meaningful move for stocks is another run at new highs or a break below the late August lows.
The one constant the last 3 weeks, volatility, has contracted a bit the last few days after a record string of 7 or 8 consecutive sessions where the S&P 500 had a 25+ handle range.
While the FED remains the 800 pound gorilla in the room, no doubt there are plenty of other concerns on the markets plate. Valuation issues have become more prescient as the focus on global growth intensifies. China is a major variable in terms of both their lower growth rate and the credibility of the data they report to the market.
The recent refugee crisis highlights the mess that has become the “extended Middle East” as identifying “good guys” and “bad guys” by boundaries on a map has become irrelevant.
Make no mistake, the FED interest rate decision is front and center and by 2:00 PM Thursday its’ impact will have been over analyzed 10 fold for starters. After all, there are 2 possible outcomes, either of which will leave base interest rates at historically low levels and neither of which will have any impact on Q3 earnings set to commence 3 weeks hence, or for that matter full year 2015 earnings 4 months from now.
So where does this leave us?
The FED appeared to be on track for an initial rate hike at the September meeting until the stock market broke sharply lower the third week of August.
While the stock sell off was exacerbated by turmoil in the Chinese markets and an unexpected devaluation of the Chinese Yuan, the technical underpinnings of US Equity markets had been deteriorating for many months. The devaluation reverberated through emerging markets around the globe, many of which were already under the weight of plunging commodity and raw material prices the last few years as demand from China has declined rapidly during the last decade.
This of course has capped the inflation outlook near zero for anything related to raw material and or commodity prices.
Thus the FED is stuck if it wishes to remain handcuffed by its guidance the last few years of wanting to see a clear path for inflation hitting 2% before it begins the process of normalizing interest rates.
Of course the FED could term the shortfall in inflation “transition”. That’s FED speak for temporary. This would allow the FED to focus on data showing positive growth like the Q2 GDP report that was recently revised to +3.7%, the better than expected retail sales numbers reported on Monday, and the trend of many states and municipalities and ledge employers raising minimum wages, many of which have yet to go into effect.
The reality is a strong preponderance of body language and statements from senior FED officials has been telling us the FED really wants to get the first rate hike behind it.
Case in Point: On Friday, August 28 St Louis FED President Bullard spoke and made a strong point that the FED was still on track to begin “normalizing” interest rates this year, despite the extreme stock market volatility earlier in the week.
These comments came at the end of a week when numerous high level “wanna be” FED influencers from Larry Summers(former US Treasury Secretary) to Christine Lagarde(IMF) and others had said it would be a mistake for the FED to raise interest rates.
Why is this significant? A year ago, on October 16, the stock market was in the throes of the sharpest correction in 3 years with the S&P 500 10% off its highs just a month earlier. October 16 was also the morning of the infamous bond market “flash crash” when the 10 year note traded from 2.00% to 1.80% in less than 10 minutes.
Later that day the same Kansas City President Bullard made what later became highly publicized comments that “the FED should consider delaying the end of its bond-purchase program to halt a decline in inflation expectations”.
The stock market responded with a strong 3 week rally, taking the S&P 500 to new all time highs on November 5th. Mission Accomplished!!
We hope the FED values its independence from outside influencers enough to stick to its principles and does the right thing to begin to normalize the term structure of interest rates after 7 years of ZIRP.
It’s time to “Rip the Band-Aid Off”. The bleeding stopped a long time ago and the scab is long gone!!