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As the market remains volatile heading into the one of the most anticipated FOMC meeting since the crisis we are left with more ambiguity than ever before. The Jackson Hole “Economic Policy Symposium” where the central bankers, which traditionally has brought us more comfort through certainty, became a convolution of economic rhetoric.


Jackson Hole “Economic Policy Symposium” has been the one event every year in which our Federal Reserve discusses economics and monetary policy. It is hosted by the Federal Reserve and attended by Federal Reserve members, which includes invitations of other central bankers and economists from around the world.

Prior to other major economic events and monetary policies, Jackson Hole has given us a more candid and clear view of what to expect going forward. There is usually a unified voice and theme, which brings forth certainty. Even Bernanke had used it as a platform to introduce another round of QE and other market stability policies.

What was missing this year, I guess the biggest surprise before one of the most anticipated FOMC meetings ever was the absent of our very own Federal Reserve Chair, Janet Yellen. In fact several of the FOMC voting members are not attending. Why are so many Fed members, especially FOMC voting members NOT attending their OWN event? Who knows, perhaps they don’t want to tip their hand whether or not they will be raising rates in September. They would certainly be asked about it and rather than answer, they just decided not to show up to their own conference.

Courtesy of wikipedia

Rate Hike?

So the question remains; is the Fed raising rates in September or December or even this year? Well that all depends on which Fed President or Fed Governor you talked to that DID attend. As an economic wonk, I watched each interview and each one sounded completely different. The one common theme among them all was “data dependent”, the new Fed go to phrase for “We really don’t have a clue.”

Fischer’s Fear

The Vice Chair, Stanley Fischer was the only big player at the event and spoke about Inflation, which was this year’s theme.

Courtesy of wikipedia

We must remember, as we listen to Stanley Fischer, that DEFLATION is a scary word and nightmare and major concern of the Fed. The Fed is deeply rooted in Keynesian economic theory and DEFLATION is the boogie man that was the culprit of the Great Depression and the Fed wants to avoid that at all costs.

The Fed measures inflation with the Price Consumption Expenditure (PCE) and the Consumer Price Index (CPI). I have written at length why these are no longer measures of inflation, but rather measures of cost of living (which are NOT synonymous), but that is for a different time. This is what Fischer stated in his speech at Jackson Hole:

“Although the economy has continued to recover and the labor market is approaching our maximum employment objective, inflation has been persistently below 2 percent. That has been especially true recently, as the drop in oil prices over the past year, on the order of about 60 percent, has led directly to lower inflation as it feeds through to lower prices of gasoline and other energy items. As a result, 12-month changes in the overall personal consumption expenditure (PCE) price index have recently been only a little above zero.”

“… a larger effect comes from changes in the exchange value of the dollar, and the rise in the dollar over the past year is important reason inflation has remained low.”

He even quoted from the July FOMC Statement:

“The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

He goes on to say:

“Reflecting all these factors, the Committee has indicated in its post-meeting statements that it expects inflation to return to 2 percent. With regard to our degree of confidence in this expectation, we will need to consider all the available information and assess its implications for the economic outlook before coming to a judgment.”

“Of course, the FOMC’s monetary policy decision is not a mechanical one, based purely on the set of numbers reported in the payroll survey and in our judgment on the degree of confidence members of the committee have about future inflation.“

“For the purpose of meeting our goals, the entire path of interest rates matters more than the particular timing of the first increase. With inflation low, we can probably remove accommodation at a gradual pace. Yet, because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2 percent to begin tightening. Should we judge at some point in time that the economy is threatening to overheat, we will have to move appropriately rapidly to deal with that threat. The same is true should the economy unexpectedly weaken.”

The majority took the tone of his speech as Hawkish and that he was saying they are going to raise rates, simply from the one line. “With inflation low, we can probably remove accommodation at a gradual pace”, while ignoring the rest. In fact that is the general tone that is believed by many, which the Fed is going to raise rates in September or maybe December.

For me and the rest in the minority camp, all I heard was more Fed ambiguity. He did raise concern about the “Strong dollar” and very low inflation measures. And as I previously stated DEFLATION is a real concern. What do you think will happen if they raise rates and look to a tightening policy? The dollar will rally and we will have MORE deflationary pressure. On deflation concerns alone, the Fed is less likely to raise rates.

His full speech can be found here: U.S. Inflation Developments by Vice Chairman Stanley Fischer

Market Reaction?

As we are treated to the parade of asset managers, fund managers, and financial experts on CNBC & Bloomberg, the common strategy is: “Buy the dip!” – with a hint of caution. The caution comes from the Fed uncertainty and the uncertainty is not just about whether they hike or not, but whether the hike is a theme of “tightening” or getting back to “normal”.

There is wide spread concern among those in the market, which is a growing realization, that the market valuation is built upon Fed inflationary monetary policy (zero interest rates, bond buying, and mortgage buying). You would think that with QE “officially” ended, that this concern has already been addressed. But for those in the know or those that have been paying attention, QE never really ended at all. It was more marketing than substance. The Fed is still buying bonds (holding down the yield curve), still buying mortgage back securities, rates are still between 0-25 bps (ZIRP) and still increasing money supply.

This time, rather than empty words of “ending QE” it will be substance of actually raising rates. That will certainly impact the bottom line. While a 10 or ever 25 bps raise will have very little impact on rates and carrying costs, it could trigger a race for the exits. If the market generally feels this is the first of many to come rate hikes, a return to “normal”, we could see a huge rotation in the market which could send equities and bonds lower (yields higher).

The Fed has a Dual Mandate (full employment and moderate inflation). I would argue there is a third mandate, which is the value of the financial markets. This new unspoken third mandate came into existence only because the Fed became the financial markets largest participant. They are the largest U.S. bond holder, the larger MBS buyer, and the largest lender of credit for financial asset purchases (margin). They are certainly paying attention to the equity markets and bond markets. To think they have ignored the volatility this week and heading into their FOMC meeting is to be naïve.

Support & Resistance

INDU 16,500
I still am looking at this 16,500 level as a “straddle strike”, meaning that we will rally back up to 17,400 or back down to 15,800 fairly quickly. The market could see some wide consolidation around 16,500 until the FED gives us clarity, which means get ready for some swings and volatility.

NDX 4300
The tech heavy index made a big move back, almost to unchanged from the selloff. I would expect some selling pressure above the 4300. Watch 4300 into the close as to whether there is any support in there or if this is just a resistance level and we start heading south to 4000 again.

SPX 1980
Like the Dow Jones this is the “straddle strike” and a sloppy consolidation range around here is in the cards. I suspect a move back down to 1960 in the short term and a possible pop to 2000. However, expect volatility heading into the FOMC meeting. Long Gamma is the only logical and safe position to have.

RUT 1160
So far the broadest measure of order flow is not looking good. The bounce off the lows was weak and we stalled at the 1160 level. Expect some consolidation in here with some sloppy intraday moves. Getting above 1180 on volume and holding there would reflect confidence in the equity markets, but I think that might be hard pressed until the market is confident about the Fed and low rates.

Trader’s Market

This is a traders market, if you are an investor be careful with the “buy the dip” strategy. The odds are good that “buy the dip” would work if the Fed doesn’t raise rates and remains accommodative. If you are not hedged, you should be.

For traders, it is a Long Gamma market and feel free to lean Deltas against Gamma Long or Short – because it is a “pick’em” market condition. Gamma is your friend .

3 Responses to “Ambiguity”

  1. Luana says:

    Could you please explain in what way is the Fed the “the largest lender of credit for financial asset purchases (margin)?

    Thank you, Michael

    • Silexx says:

      In the simplest of terms, all the Fed member firms are also tied or directly the clearing firms.

      Between the Discount Window (early part of the crisis) and now excess reserves that are bonded to zero rates, has allowed the member firms to expand margin.

      The clearing firm is lending investors money on their own leverage balance sheet – which ultimately is the Fed.

      This is not a good or bad thing, it is simply reflecting the reliance on the Fed to provide capital and credit at very low interest.

      Remove the reserve leverage and raise the rates – and you would have extensive margin calls.

      Initially during the Crisis – from 2008 – 2011, the Federal Reserve (through the Discount Window) lent up to $400 billion to member firms DIRECTLY. The Discount Window is used as the lender of last resort. During this time, the Fed started buying MBS assets to free-up capital restraints and the requirement of going to the Discount Window. Technically speaking, the Fed swapped the liabilities so the member banks didn’t have use the Discount Window (short-term borrowing).

      If you look at the reserve balances prior to 2008, which were in the 10 billion range and compare it to the current 2.8 trillion – it is enormous. Add in the increase of money supply and there is a boat load of created “reserves”, which allows for excess credit creation.

      Inflating asset prices has worked, based on creating additional credit availability on zero interest rates.

      The one problem I see is the velocity of money is very low. If that picks up, the other problem we would have is a rapid acceleration of inflation.

      As Bernanke stated in 2014: “We did the right thing, I hope.”

      He openly admitted it was an experiment, which should work theoretically.

  2. Luana says:

    Thank you. What you wrote me might be interesting to others to read and know about. I don’t think I’ve heard the term “clearing firms” in regards to the Fed before. This information adds more clarity (and complexity) to why the Fed is in such a pickle. Obviously with today’s market drop, one can see that the obscuration and “rock and hard place” is still lurking. It sure is a mess….