I hope everyone had an excellent Thanksgiving and enjoyed their holiday shopping. The market has been moving in fits and starts. The data has certainly been mixed, from weak holiday sales and the recent better than expected Labor Report. However, nothing has been horrible and unbelievably good. It has been mediocre at best. The biggest concern that remains is how much is the economy reliant on the Fed?
The majority has bought hook-line-and-sinker into a Fed rate hike, for no other reason than the Fed has set those expectations. I wrote a lengthy morning preview about Message Crafting. Remember, by the Fed’s own words the QE, Bond Buying, Low Rates, and the whole shebang was a temporary, emergency, extraordinary, something or other and that it wasn’t supposed to last forever. To some extent I think they needed to tell themselves (fool themselves) into believing it, because at its core there is no way you can forever print your way to prosperity. We have and are seeing the failure of endless debt financing (mostly to fund socialism); Detroit, Chicago, Greece, Spain, Puerto Rico, and the list goes on. Certainly all these situations are different, but the common core is endless debt financing. The Fed is operating from the same playbook and have expanded their balance sheet well into the multi-trillion.
Most of the stuff the Fed has done recently is nothing more than window dressing, because nothing has really changed. They announced an END to QE, yet the Fed continues to be the largest purchaser of U.S. treasuries and mortgage back securities. Not only did it NOT really end, they continue to maintain a massive balance sheet – through rolling existing debt. In essence they are NOT reducing/paying down their debt.
Courtesy of FRED
This “Rate Hike” talk is nothing more than MORE window dressing. We are not actually running a ZERO Fed Funds rate; the actual policy is between 0 – 25 bps. If you monitor the NY FED’s daily Fed Funds rate it has been running at 13 bps points. So even if the Fed “hikes” rates to 25 bps, then they really haven’t done anything other than move it to upper end of their EXISTING policy. Again, just more window dressing.
What is the big concern that no one seems to be talking about is the reliance on the current and ongoing Fed policy of not just low rates, but more importantly the bond buying, mortgage back security buying, and expansion of money supply. Even with the rate hike, they are running ultra-easy monetary policies.
The rate hike, just like the ending of QE, creates a perception that everything is doing better and can certainly be a morale booster. However, pull back the marketing curtain and nothing has really changed.
Yet among all this silliness of window dressing, I am still not convinced the Fed will hike rates. They certainly have room to do so, since they are already running a 0 – 25bps Fed Funds rate (even though they call it ZERO), but there are other factors and the biggest one is the dollar and deflation.
True, a 25 bps hike doesn’t change the math very much for the investor and private sector, it does change perception and perception can drive order flow. The ECB and Japan are expanding their easy monetary policy and even talked about negative interest rates, while the U.S. has been talking about raising rates. The dollar index has been rallying, pushing down on trade weighted and currency weighted inflation. Consumers already see it at the gas pump – as trade/currency weighted inflation has become disinflationary. CPI and PCE continue to show disinflationary pressure. We could soon move into the deflation range.
It is DEFLATION that remains the predominant concern of the Fed. If the rest of the world continues to ease as the U.S. tightens, we could see the dollar rally against foreign currencies and disinflation turn quickly into deflation pressure – as measured by the PCE, PPI, and CPI. That translates to wage stagnation, a rise in the trade deficit, weak exports, and weaker earnings.
Of all the reasons I have listed in the past as to WHY the Fed will not raise rates this year, it is the strong dollar and potential deflationary pressure that I think becomes a risk factor that Fed is not willing to take.
Last week’s down-up knee jerk moves show how volatile this market really is and also how reliant we are on the Fed.
Support & Resistance
We sold off to the 17,400 level only to see a power rally back to the resistance area for another attempt to move higher. We are flirting in the 17,800 – 17,900 range – but with no break-out. The Fed decision (whether they raise rates or not) will certainly be a catalyst event, so expect volatility. I think we could head back to 17,400 just as easily as blasting to 18,000. Just expect volatility.
We filled the gap from 4600 to 4500, which was a great day for traders. We are now back up into that 4600 – 4700 band and pressing the 4700 resistance area for another attempt to break-out higher.
Much like the Dow Jones we saw the index come off and almost visit that 2050 support area before blasting back off towards 2100. I expect to see a 2000 – 2100 sloppy trading range until we get the Fed decision, then it is anyone’s game. The VIX is in the 14 range after that rally, which is too low in my book – with the Fed decision around the corner.
Unlike the Dow Jones and S&P 500, the Russell didn’t rally back up to its previous resistance level of 1200. The Russell has been stuck between 1140 – 1200 since early October. What we need to see happen is a break-out above 1200 with volume and certainty to confirm any trending rally after the Fed decision. I think a visit to 1140 is in the cards as well – after the Fed decision. That is a very important support area, that if it doesn’t hold we could head to 1120 or even 1100 and that would translate to drop below 17,000 in the Dow Jones and below 2,000 in the S&P 500.
Will the Fed raise rates? I am still not sure it will because of the possibility of deflation, not to mention a litany of items that can bring disruption.
If they don’t raise rates, will the market rally? Well that depends on how the marketing is spun, on one hand it could boost inflation pressure and also buoy borrowing and spending.
They have room to raise rates, no doubt – the question that continues to play in my mind is how will the dollar react – because the dollar action will drive ALL market activity.