The market remains under volatile conditions, as if the recent FOMC meeting created more ambiguity than certainty. The Fed did not raise rates, but maybe they will in October or December (the next FOMC) meetings. The market didn’t rally as many expected when the Fed didn’t hike rates and instead sold off again. Last night Yellen spoke and that only added MORE uncertainty as to the future of the FOMC and rate hikes.
The bond market, after the recent FOMC meeting, rallied sending yields lower. We saw the 10 year yield call to 2.1% and for a while it look like we were heading toward 2%. The bond market was pricing in NO RATE hike for the rest of the year – it has seemed settled.
Then last night Yellen spoke and everything changed again. It was as if the recent FOMC meeting and NO RATE hike didn’t exist, now Rate Hikes are back on the table. Yellen actually contradicted the recent FOMC rate decision and went as far as to say it would be appropriate to RAISE rates “sometime later this year”. Of course that was quickly followed by the decision to “normalize” (to continue to hike rates) would remain dependent on economic data.
Courtesy of FRED
Her speech last night at the University of Massachusetts at Amherst was directed at the market only. She was trying to tell the market what it wanted to hear and at the same time make sure the market knows that it would be a “one and done” as any REAL long-term rate hike and return to “normalization” was off the table. It was an appeasement speech and those are the most dangerous speeches to make, as they only stoke the fire of volatility.
The bonds sold off over-night, yields spiked back up towards 2.2%, futures rallied over-night, all because she made an appeasement speech. The problem is that a speech at a University is NOT POLICY. Sure she is the Chair-person of the Fed and can pretty much set policy as she wishes, while over-ruling other members who may descent. Yet, to contradict the recent FOMC policy statement and decision by the Chair-person of the Fed has set a level of expectations for the rest of the year.
What happens when the Fed does NOT raise rates at the October meeting or December meeting? What are people and the market to take from Yellen? Is she the boy who cries wolf one too many times?
October Rate Hike?
There is not a lot of economic data to come out between the recent FOMC meeting and the next one on October 27th. Usually the Fed doesn’t make changes to Fed monetary policy during the October meetings and there is NO press conference, it is usually just a statement and for the most part October FOMC meetings are usually never given much weight.
Regardless of her speech, the Fed will most likely NOT make any changes to monetary policy in October – simply because not enough data or time has transpired between the last meetings. Yet now she has RAISED expectations of a rate hike for the October meeting.
All Yellen has done is inject more potential volatility into the market. Probability is still low for an October Rate Hike, but I believe potential volatility will be elevated. We will most likely see the VIX decline today and into the October meeting, if the VIX falls into the 15 range heading into the October meeting I think it will be getting too low.
The only real probability to consider is the December FOMC meeting for any potential rate hike. Yet, December is a ways off and I am sure Yellen will HOPE that the market will forget that she made any indication of a RATE HIKE.
Testing the Market
On one hand Yellen’s speech was testing the market reaction if she implied a RATE HIKE for 2015. She wanted to know if the market could handle it and not panic. One the other hand, I am sure Yellen regrets making such a bold statement as she has NOW sown the seed of those expectations.
Dollar and Deflation Risk
There is one other factor to consider and that is the dollar and deflationary pressure. The dollar index is rallying. A move up to 98 will certainly bring deflationary pressure to the economy. If the Fed raises rates and the index is pressing on the 98 resistance area, we could see a break-out covering rally and that would send the dollar higher and create significant short-term deflationary pressure.
Courtesy of FRED
Remember deflation is the Fed’s worse nightmare and something they are trying to avoid at all cost. The PCE and CPI have been under pressure and not showing signs of inflationary pressure at a level to get towards the Fed’s target of 2%. While some think the Fed’s is myopically focused on unemployment, the reality is they have removed any measure of U3 from their FOMC statement as a decision to change monetary policy, but inflation remains a key indicator for monetary policy.
What the media is NOT talking about is the dollar and the inflation target, which I think are the core factors driving Fed monetary policy and if we are to gauge the dollar, PCE, and CPI – the Fed will NOT raise rates.
Courtesy of FRED
Support & Resistance
We broke down below 16,200 intra-days but then rallied into the close. We could be putting in a support at this level and ready for a bounce up to 16,600 – 16,800 range again. However, year-end trends are harder to determine because of the Fed’s ambiguity. Watch the close, we could close above 16,400 and that could signal a rally next week.
Like the rest of the market we had an intra-day sell-off that converted into a rally by the close. A strong move up to 4300 today is in the cards and a follow-through to 4,400 next week. Apple can be a big driver in this index today and next week with the iPhone release.
The action yesterday looks like a short-term bottom and support may have been put in. Watch the 1960 level and to see if we can rally and head into that zone. A strong rally into the close could mean a strong follow-through next week and a move towards that 2000 level. VIX should come off today and we could see it hit the high teens.
The Russell has been under preforming the rest of the market and that remains a concern. We need to see some real broad based strength in this index and a solid move to 1160. Resistance will kick in around 1160 – 1180 zone, but watch to see how we close and the strength of the rally.
It is far too difficult to call a trending market for the end of the year and that falls squarely on the shoulders of the Fed. The market is moving in fits and starts, not knowing where to go and what to believe. No Rate hikes vs. Now talk of 2015 rate hikes, weak economic data vs. revised better economic data, weak inflation vs. deflation, low unemployment vs. low participation. The list of conflicting data, information and even Fed positioning only adds volatility to the market.
I think we could be setting up for a strong short-term rally into recent resistance levels, but a break-out above that will be based solely on the perception of the Fed, change in rates, and forward guidance.
The only possibility of a rate hike in my very humble opinion is a “one and done” scenario in December, coupled with a message that the Fed will NOT be raising rates for some time after that. That “one and done” rate hike would be only to quite the media and the market, to hopefully take focus off the Fed and back on the economy.
I believe the Fed has failed in their market crafting and spin, which is directly seen by the recent spike in volatility.
Today’s opening rally is proof this market is tied more heavily to the Fed, their monetary policy, and the rate hike perception rather than real economic data or fundamentals.