FOMC Tea Leaves
While the market has already strongly reacted to Fed FOMC expectations, the media is slowly catching on. We will likely see more attention turn towards some recent and current economic data to justify the FOMC statement. The geopolitical concerns, Ebola, ISIS, Hong-Kong, and the rest is going to take a back seat to economic data and the Fed this week. Then we turn towards the mid-term elections. You are probably sick of hearing my views on the Fed and upcoming FOMC meeting, yet it is the catalyst for the market.
FOMC Tea Leaves
We should not expect any change in monetary policy or actions in this next FOMC statement. This scheduled FOMC meeting will not address economic forecasts, rate projections, and there is not even a scheduled press conference with the Chair. These are all probably good things in light of the mid-terms, the Fed needs to take a dovish stance, but at the same time not take the spotlight away from the politicians (Democrats).
This leaves the media, economists, and political pundits to read into the statement for clues about Fed policy. This creates a fickle paradigm, as the FOMC statement usually looks boiler plate with only a few words changed, some present tense changed for past tense, perhaps one sentence added and another removed. The Fed likes to keep things on a slow and even keel. So we shouldn’t expect much, or should we?
Courtesy of wikipedia
I hate reading the “tea leaves” to try to interpret what the Fed may or may not do, so I like to resort to looking beyond just the FOMC statement and at current monetary policy, the math, and action. Words can sooth and bring hope, but they should never be mistaken for action. However, as much as I hate trying to interpret an FOMC statement, that is what we are left with and that puts the Fed in an interesting conundrum.
What will change?
Let’s review what will be addressed; using their boiler plate FOMC statement and what might change.
The first paragraph talks about the economy in general. Here we may see some changes as it refers to their Dual Mandate (“Full Employment” and “Price Stability – Inflation”). They will certainly refer to the “significant underutilization of the labor market”, meaning that REAL (U6) unemployment remains stubbornly high and job creation is weak (mostly part-time), which has been a running theme in their FOMC statement to justify accommodation. Then they will mention inflation and this will certainly change to indicate how it is running BELOW the Fed’s longer-run target rate of 2% (or is it now 2.5%) and they are concern. This will be interpreted that the Zero Interest Rate Policy (ZIRP) is going to be here for a while longer than many economist thought.
The rest of the FOMC statement starts getting into the meat of any policy changes and general interpretations of economic activity. Which the first paragraph has set the stage for justification as to any changes we may see.
Any big changes that will jolt the market will be:
DEFLATION: A stronger statement concerning the drop in inflation rate (CPI), which is DISinflation, not Deflation. Deflation represents the opposite of inflation, which is a DECREASE of overall price levels over a period of time. Disinflation is just inflation that is declining. Expect to see media pundits and even members of the Fed use the word DEFLATION in a disingenuous manner to elevate concerns and bring justification for continuing ZIRP and accommodative policies.
Courtesy of shadowstats.com
UNEMPLOYMENT: The Fed will certainly reiterate the concern about unemployment and job creation, which continues to help justify their ZIRP policy.
Courtesy of FRED
QE ENDS: The section about “tapering” QE will be in there, which they are expected to announce the end of QE in this FOMC statement. However, this is where we could see surprises of a continuation, but if not they could mention or imply that some other accommodative policy will be considered based on economic data. I suspect, even with the end of QE3 it will be done with in a Dovish tone with a “but”, “if”, or “depends”.
All of the above is already in the statement; it is just how they change their tone and words. What might be new in the FOMC statement is the concern about the dollar strength and how it may impact forward GDP growth. It may include concerns about exports weakening and the Fed may translate that with concerns about weaker job creation. Any new additions to the FOMC statement will certainly lay the ground work for expectations in changes of the Fed policy. Again it is only words at this point and not policy, but those words will create a perception that can drive market activity on Wednesday and set the expectation for the future. Just today, the Durable Goods declined by 1.7%, the largest since January. Which is more fodder and justification for the Fed’s Dovish policies.
In conclusion – my expectation is for no real changes to monetary policy, but a very Dovish tone that is justified with the two components which they are charged with; weak labor market and now a threat of “deflation” (really disinflation).
Market Reaction = 3 outcomes!
Dovish (no policy changes) = If they don’t change any actual policy, but just release a Dovish statement and imply future accommodation and longer ZIRP policies, the equity and bond market will rally (yields will decline). However, I don’t think we will get a significant lower move in the dollar index and oil may not rally back that strongly yet – not until policy changes comes forward. This is the safer play for the Fed, pushing accommodation policy changes out to the December or January FOMC meeting.
Dovish (with policy changes) = If the actually change policy (pause the taper, extend QE3, announce some other accommodation) coupled with longer-term expectation of ZIRP, we will see a stronger rally in the equity and bond market, coupled with a stronger sell-off in the dollar and a stronger rally in oil prices. I feel this is a lower probability as we head into the mid-terms.
Hawkish = Lastly – if the statement remains vague, not too “Dovish” and they just end QE without clues of further accommodation or more ZIRP the market will read this as Hawkish. The equity and bond market will sell off (yields will rally). The dollar will rally and oil will sell off further. While improbable, not impossible. The Fed governors and Keynesians have already started the Dovish tone already leading into this meeting.
In just over 24 hours (Wednesday at 2pm ET) we will get this new FOMC statement and review it for the changes and words. The market WILL react into the close and for the rest of the week.
Support & Resistance
The pre-market futures are looking strong, but I don’t see any justification for a strong rally until the FOMC statement confirms a Dovish Fed. I think we could consolidate around the 16,800 level +/- until late Wednesday.
The tech heavy index has seen a strong gapping rally into what is expected to be a Dovish Fed.
I think we could consolidate in here before the Fed FOMC statement, which could push this index up to 2000. The VIX should come off a little in the next couple of days and then get crushed down into the 12 level after a Dovish Fed statement.
Keep watching the Russell this is the index that continues to give us the best indication of order flow. Right now it is pricing in an expectation of a Dovish Fed, but is consolidating until we get the “official” FOMC statement.
Last of the Hawks!
The two voting Hawks on the FOMC (Plosser and Fisher) will certainly vote AGAINST the Dovish changes to the policy statement. They are also on their way out and have announced their retirement, meaning that we will most likely see one big happy Keynesian family all voting in unison with the Fed Chair, Janet Yellen.
Regardless if the Republicans win the Senate and remain control of the House, the Fed will firmly be in the Dovish liberal camp and will be there for years to come. This mid-term election is a battle, not the war and if we get Warren to win the Democrat primaries over Clinton (which I believe will happen), she has a real shot at taking the White House and with Yellen running the Fed, I think we could expect massive changes in Fed power – expanding into fiscal and legislative.
Unfortunately there are no more strong and outspoken real Hawks or Austrians left after Fisher and Plosser retire (pushed out). Certainly none will be welcomed going forward and I don’t expect to see any of them arrive in the near future.