Europe offers breathing room?
While I have been adamant that the Fed will NOT raise rates in December, one thing has changed my mind as it comes back to my CORE focus on the dollar and dis-inflationary pressure. We must remember at the end of the day it is the dollar and inflation/deflation that drives everything, even ultimately the Fed decisions.
Europe offers breathing room?
Last Thursday we saw the dollar take a beating as the euro had a gap move higher based on the ECB issuing a far smaller stimulus package than expected. ECB President Draghi has also had a slightly more “hawkish” tone and the rhetoric from the ECB continues into this week.
Courtesy of SILEXX
While that did send a knee-jerk move into equity markets around the world, it also did something else – it gave Yellen some breathing room to raise rates, while simultaneously reducing deflationary fears. The CPI / PPI / PCE – all inflationary indices that Fed monitors have been in a dis-inflationary trend. While not deflation yet, they are getting close and it is those concerns driven by a strong dollar that would ultimately limit the Fed’s ability to raise rates.
While the rhetoric out of the Fed has been about raising rates and some mild cheer-leading about the growing economy, the data is telling us a more tepid story. Consumer sales weaker, stagnant wages, weaker real job creation (once participation rates are considered), GDP growth less than expected, and dis-inflationary concerns. Certainly some of the headlines, if cherry picked, can show a far more optimistic outlook, but taken in the entirety – it is a mild recovery at best.
Currency War = Deflation!
The problem has been the currency war as the Western nations, now including China, have been increasing their stimulus and lowering rates. The rest of the world is taking a far more “easy money” policy, all while the Fed is talking about ending “easy money” and raising rates. This battle has sent the dollar roaring higher (over 20% against the baskets), which have sent commodities (oil, gold, soybeans, copper, etc.) down sharply. Exports are weaker and the trade gap widens. Wages stagnation continues to be a problem, so much so that it has become a political hot-button with “raise the minimum wage” movement – playing heavily into the next political cycle.
Yellen needs Europe and others to back off their “easy money” to give her room to raise rates without risking the dis-inflationary pressure becoming actual deflation. The Fed has targeted 2 to 2.5% inflation rate, they need the dollar to weaken and need to boost inflation. The Keynesian theory is to create inflation you need to lower rates, increase the money supply, and stimulate. That is what the Fed is doing, but it is NOT working and now with our trading partners becoming more aggressive in their own inflationary “Easy money” measures, it is exacerbating the dis-inflationary problem.
Yellen got what she needed when the ECB last Thursday shocked the markets by limiting their stimulus program and back-offed the “negative interest rate” talk. While I am not totally buying into the ECB story that they have all of a sudden become more hawkish, it has given Yellen some breathing room to take rates up to the upper bound of the current 0 to 25bps “zero rate policy”. Perhaps there was some back door conversations and President Draghi is tossing a bone to Yellen, because I am certain that the ECB didn’t take a 180 degree turn on their monetary policy. It is important to remember they still injected stimulus – so it is not like they turned off the spigot.
Courtesy of wikipedia
It is this single action and NOT any U.S. economic data or changes in our economy that has given me pause and has changed my opinion that the Fed could raise rates this December. However, it is still ultimately window dressing. They are NOT stopping their bond buying. They are NOT stopping their mortgager back security (MBS) buying. They are NOT stopping their increase in the monetary supply. They are NOT reducing their balance sheet. They are NOT even raising rates above the current policy of 0 to 25 bps.
One and Done!
If they do raise rates to 25 bps, it is a “one and done” strategy. It is to quite Congress, the markets, the media. It is to sell some confidence about the economy improving and boost economic moral. Certainly important, but nothing will have really changed. It also gives them room to cut again, if or perhaps when needed. The problem has been and continues to be “message craft”, as the Fed continues to forward the assumption that their current monetary policy is a temporary measure, thus setting the expectations that at some point they will raise. Change that assumption and you end the expectations, until then expect the market to be driven by and married to each FOMC meeting.
The markets now sit precariously back at those support levels, waiting on the Fed. The expectations certainly remain high they will raise rates and even I have given it a higher probability, as the ECB has taken some of the strength out of the dollar, thus minimizing dis-inflationary pressure if they raise. Yet, while I give it a higher probability, I am still not firmly in the Fed is going to raise camp.
Support & Resistance
INDU 17,400 – 17,800
This index has been rattling around with some high volatility in his range. Certainly 17,400 is not becoming a short-term support area, that if it breaks down we could see 17,200 quickly. The upside stall area is just above 17,800. I don’t think we should see a break-out in either direction until the FOMC meeting next week.
NDX 4600 – 4700
We did have a “fill the gap” moment down to 4,500 before we bounced back in mid-November. Since then we have been in the 4600 – 4700 range. A drop to 4500 can certainly happen, I suspect the index to stay range bound until FOMC meeting.
SPX 2040 – 2100
Much like the Dow Jones we saw this index bottom out in mid-November, rally back and pretty much suck in the 2040 – 2100 range. We are testing the 2040 range again and could see a drop back to the recent low of 2020. However, I think we must wait for the Fed’s FOMC meeting to determine if we are going to rally above 2100 into year-end or sell off below 2020.
Of all the indices it has been the Russell that continues to be the best measure of order flow. We have been in a bear market since June and finally bottomed out in late September. Since then we have not been able to rally back to the 1280-1290 highs of June. 1200 seems to be a resistance since early November and we have bounce off the 1140 support numerous times since early October. We are now testing that 1140 level again – can we hold? I am not sure – but I think the Russell index will be the tale-tail sign for the market heading into the end of the year.
Europe offers breathing room?
Fed has room to raise, Europe has given some extra breathing room by releasing some dis-inflationary pressure. Do they have the cojones to do so and suffer possible market volatility heading into the end of the year? How much breathing room has the ECB really given the Fed, some but I don’t think it is enough and we will see the dollar rally on any hike and that will renew dis-inflationary pressure.
The ultimate question, how much dis-inflationary pressure can the Fed handle?