Primaries and the Fed

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This week should be pivotal for the markets. We have another “Super Tuesday” that could be the decider for both the GOP and Democrat primaries, which will certainly drive some volatility (depending on who slings ahead). Yet this is more of a long-term market driven story that ultimately plays out in November. What will drive short-term volatility this week is the FOMC meeting and the Fed’s tone.


Primaries and the Fed

The Primaries (Super Tuesday Part 2)
I was shocked that Bernie was able to win Michigan. I wasn’t shocked that he could, I just didn’t think the 18-29 year olds would go out and vote. Bernie has over 70% of the 18-29-year-old votes, who have embraced Socialism, much like what we have seen in Spain and Greece. After spending time behind the Iron Curtain, I can’t believe anyone would support someone that honeymooned in the Soviet Union and speaks highly of Castro’s Cuba.

Then we have Hillary, with one of the lowest trust factors and who knows how many skeletons in her closet. She is part of the old establishment party, much like the Bushes are to the GOP. People are tired of the old-school political dynasties.

Meanwhile we have Trump, who is like a bull in a china shop. Personally, I don’t know what to make of him and I am certainly frustrated. On one hand Trump is a businessman, leader, and strong negotiator, which are certainly skills needed in the Commander and Chief. However, his diplomacy or lack thereof is at the least going to alienate allies. Not to mention his unfiltered rhetoric, while entertaining is certainly concerning.


courtesy of wikipedia

We certainly have two extremes that could win, a Communist vs. Capitalist. If we get an inkling this week who is going to win their respective primaries, it could certainly drive more volatility into the markets as we watch the horse race play out.


Fed Ideology

The Fed currently leans far more “Left” (liberal / Keynesian). In fact, reviewing Yellen’s previous academic papers, she has argued for more Socialist type policies. It is important to note that President Obama has appointed every Fed governor, first time since inception that a President has been able to do so. If Clinton or Sanders take the Presidency, the Fed will continue to remain Liberal and with Sanders could shift even further Left. However, if Trump wins we could start seeing a shake-up of the Fed.


courtesy of wikipedia – Orwell’s English Socialist Party

The confusion about the Fed today is that the media and pundits don’t see the Fed as political. While to a certain point that is true, however economic models are the engines of political ideology. The Fed governors are entirely Keynesians, which is an economic theory developed during the Great Depression by Lord Maynard Keynes (its name sake). It is the economic theory that helped FDR drive through his social policies. Socialism needs support from economic theories. Keynesian economics is rooted in the concept of “central planning”, that the government needs to ALSO take control of the financial markets and economy when it is “not working”. I have always asked what is defined as “not working” and who is anyone to tell others it is “not working”.

That being said, the current make-up of the Fed leans “Dovish” (more stimulus, more money printing, more asset purchases, low interest rates). Much like any ideology, to shift against their core belief is difficult and goes against their belief. Remember how long and difficult it was for them to raise rates 25 bps last year. It was like pulling teeth, you could almost feel the pain in Yellen as she had to announce they raised interest rates (against her judgement).

The Fed also lost their two Hawks, Fisher and Plosser. Fisher has become more outspoken of late, now that he doesn’t have to parse words as a member of the Federal Reserve. Recently ex-Fed President Richard Fisher was interviewed on CNBC and offered his most unfiltered review of Fed Policy (of which he was a part of):

“Protectionism is the crack cocaine of economics. We know that it gives you a high. But it can be super-deadly, economically speaking,”

The full interview is worth watching, which includes his views on the candidates: CNBC Fisher Interview


FOMC meeting:

Without the likes of Fisher, the Fed doesn’t have anyone that will oppose their positions, which are likely to remain Dovish. The Fed meets this week and will release a statement and any shift in their monetary policy.

I believe the Fed will NOT raise rates this meeting and will lower the expectations of raising rates for the year. Deflation pressure could be a concern again, as the ECB and Japan has taken another Dovish step forward lowering rates and printing more money. Additionally, the China slowdown and other economic data (minus the big three government headline numbers) has certainly raised a cause for concern. Yet, the Fed will offer optimism that the economy is improving.


Market Reaction:

  • Fed Doesn’t Raise Rates + more Dovish tone = Market Rally
  • Fed Raises Rates + more Hawkish tone = Market Sell-Off
  • Fed Doesn’t Raise Rates + ambiguous about the future = Market Confused and more Volatility.

The Fed is not going to raise rates this meeting, so I think there is a higher probability for a market rally. Yet, it is the tone of the Fed and how the market reads their message that can curtail any rally. We saw last week as the ECB cut rates and ramped up their money printing, the market initially rallied. Then the ECB President, Draghi, started talking and implied they would not cut rates anymore and offered a slightly “Hawkish” tone, the market then sold off quickly.

The market has three phases:

 

  1. Immediate Reaction based on ACTION! (example: Rate Hike / No Rate Hike)
  2. Short-term Reaction based on TONE and Perception! (example: Fed’s FOMC statement and/or Speech)
  3. Long-term Reaction based on MATH! (example: when action and words no longer make a difference).

Market Pricing a Rally, is it right?

The market is pricing in a Dovish Fed and a rally. The VIX is below 17 as of yesterday and the indices in general have rallied strongly back. The 10-year remains below 2% yield. Collectively the market from equities, volatility, and bonds is not pricing in a rate hike and believes the Fed will remain Dovish.


Support & Resistance

INDU 17,000 – 17,400
This is the range we should expect to see after the FOMC meeting on Wednesday. On the extremes this week we could see 16,800 or 17,600 before support/resistance kicks in.

NDX 4200 – 4500
The tech heavy index is certainly volatile. We could see a strong move higher or lower after the FOMC meeting.

SPX 1980 – 2060
The S&P 500 has made a strong move off the lows. With the FOMC meeting we could see the index rally to 2060 or fall back to 1980. At the extremes we could see 1940 and 2080.

RUT 1060 – 1120
The broader based Russell index is stalling a little after the rally. It needs to get solidly above 1100 on volume to show continued strength. 1060 looks like short-term support. I would watch the Russell index to get an idea of general market order flow, regardless of the narrower indices.


Expect Volatilty

The question is not whether the Fed is dovish or that they will not hike rates, the real question is can the Fed sell their Dovish tone to the market. If the market believes the Fed may still raise rates or has an ounce of Hawkish blood in them, we could be in for a volatility market. Draghi tried to sound Hawkish after cutting rates and printing more, the market didn’t know how to react.

I think the Fed will remain Dovish for the rest of the year and the Fed will certainly not do anything to rock the Democrats heading into an election year, they KNOW who put them in power. A Trump or GOP lead government means that when the governors terms are up – they are out.

I think we are in for more volatility rather than a trending market.

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