The “Secret” Reason Yellen Doesn’t Want to Raise Rates. Special Fed Meeting Update

I believe there is a “secret” behind the Fed being slow to hike short-term interest rates. I will get to that in a minute.

Today’s Meeting

Let’s start with non-controversial items first. The Federal Reserve Open Market Committee concludes their two day meeting with an announcement at 2 pm that interest rates will not change today. That’s what the markets are expecting. There has been all kinds of hot air coming from several Fed officials that rates need to rise now, but Chair Janet Yellen has been on the other side, sticking with her more accommodative stance. It would be very hard to believe that the majority of voting members would overtly vote against their chair.

The statement comes next and because it’s not one of the quarterly press conference meetings, it’s even further unlikely that Yellen & Co. will raise rates without releasing their updated forecast and answer questions. Regarding the verbiage, there is no consensus on what will be released.

Looking at the calendar, the most likely opportunities for the Fed to raise interest rates are at the June and December meetings which include the quarterly update. I took September off the table because it’s too close to the election and without a clear and present crisis to fight, it’s unlikely the Fed would move so close to election day.

My own stance remains unchanged since 2008. That is that the Fed should not raise rates at all until the other side of the next recession. I wasn’t referring to getting through the Great Recession. I meant the mild one that should come next this decade. After that recession, I believe interest rates will go on a 25-40 year bull market with inflation finally becoming commonplace again.

That forecast also coincides with the final crisis in Europe later this decade. One way or another, with or without the Euro, Europe’s rubber meets the road this decade. Kicking can is no longer possible. There will likely be defaults and reorganizations, but Europe should become a great place to invest in the 2020s.

Yellen & Co. Set a Precedent
Getting back to the subject line of this update, I firmly believe that the Fed’s main reason for not raising rates isn’t all that transparent. However, the “secret” I call it isn’t nefarious or with some conspiracy laden ulterior motive.

Yellen is in a tough spot. The U.S. economy is certainly strong enough to withstand a rate hike or two. It’s hard to argue that although the Fed did set all kinds of precedents in December with that increase.

  • First rate hike ever with inflation under 1%.
  • First rate hike ever with the annual social security COLA at 0%.
  • First rate hike ever with wage growth needing to jump 100% to hit the Fed’s target.
  • First rate hike ever with industrial production on the verge of recessionary levels.
  • First┬árate hike ever with GDP barely 2%.
  • First rate hike ever with inflation expectations close to 0%.
  • First rate hike ever with retail sales closer to recession than escape velocity.
  • First rate hike ever with non-farm payroll job growth continuing to decelerate.
The “Secret”
Anyway, if Yellen & Co. hike rates now or soon given what’s going on in Europe and Japan with negative interest rates, the Euro and Yen would likely fall precipitously, meaning that the U.S. dollar would strengthen dramatically. This would almost certainly lead to an enormous flight of capital out of Europe and Japan and into the U.S. Remember, capital always flows to where its treated best.

Before the financial markets were truly global, you can see how this occurred in the early to mid 1980s as the dollar soared to its highest levels of all-time. Massive capital inflows would first go into the dollar and then typically into shorter-term treasury instruments. In the 1980s, we also saw flows into large cap, blue chip stocks, which I can see happening this decade and fueling the Dow into the 20,000s.

In the 1980s, these capital inflows helped fuel the nearly vertical rise in our stock market. However, eventually, when there are enormous capital flows to one system and out of others, market dislocations grow and grow and grow. Look at how sharply the dollar began to collapse from 1985 to late 1987.

When newly appointed Fed chair, Alan Greenspan, raised rates in August 1987, the dollar still fell as stocks peaked. As the stock market began to unravel in mid-October, then Treasury Secretary, James Baker, famously warned on the morning of the October 19th crash that the U.S. was not going to intervene and support the dollar. With portfolio insurance to add fuel to the fire, our stock market crashed.

I believe the Fed fears a much worse inflow of capital into this country which may be good in the short-term, but disastrous long-term. There is much more global capital today and our financial system is much more linked than ever. Money can flow around at warp speed.

Should we see a torrent of capital flow into the U.S., these kinds of events rarely, if ever, end well. See Japan since 1990 as one piece of evidence. Should our dollar resume its secular bull market, which I think it will by 2017, we may be looking at a major global financial market dislocation later this decade as a result, something the Fed doesn’t want to contribute to.

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Apple & The Fed. A Volatile Concoction…

The FOMC begins their regularly scheduled two-day meeting today. Typically, stocks are quiet with a small upward bias. However, Apple reports earnings after the bell and that almost always provides some movement as the tech behemoth has an outsized weighting in the S&P 500, Dow and NASDAQ 100. I have absolutely no opinion on how their earnings will be and I really only care about how the market reacts anyway. The fact that it has sold off into earnings gives the bulls a slight edge to reverse the weakness by the end of the week.

Getting back to the Fed, expectations are that rates will remain as is for now with June as a less than 50% of a hike. September should be off the table as it is an election year and there is no clear and present danger to fight. So that really means that if Yellen & Co. do not hike rates in June, December is the next viable option. What a far cry from four rate hikes in 2016 as first forecast by the Fed!

Regarding the stock market, I remain in the cautious camp since last week as I believe the major indices are in the process of peaking. Apple will have a lot to do with the short-term direction of the NDX which is underperforming. None of the four key sectors are rolling over which is one reason I believe we will just see a modest pullback. Previous defensive leaders, staples, utilities and REITs are all bouncing back, but it looks like they have seen their peaks for a while and strength should be sold.

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***SPECIAL Fed Meeting Alert… A March Surprise?***

Whether you like Dolly Parton’s, “Here You Come Again”, Kenny Loggins’, “This is It”, or Europe’s, “The Final Countdown”, it’s Federal Open Market Committee (FOMC) statement day again. Boy did those 6 weeks fly by. And the markets have basically done a 180 since January 27 with the Dow going from vertically down to up and advancing from 15,940 to 17,250.

Yellen’s Cover for Standing Pat is Gone

After raising rates in December, the Fed prepared the markets for four more rate hikes in 2016. Almost to the day of that announcement, global markets began to sink on fears that the worldwide economy was slipping into recession. With that, the Fed quickly backed off the rhetoric and so went any discussion of a rate hike in January.

Yellen cited China, Europe and even lower than expected economic output in the U.S. along with collapsing oil prices are reasons for keeping interest rates unchanged.

My oh my have things changed.

  • Our stock market not only stabilized, but rallied sharply
  • Oil prices are up 50% from the bottom
  • Q4 GDP came in stronger than expected although up just 1%
  • February employment report printed a reasonably strong and better than expected increase of 242,000
  • China’s stock market calmed down and began to rally
  • European markets gained
  • ECB chief, Mario Draghi, announced an increase in bond buying and more stimulus

What will Janet Yellen say now?

She basically lost the cover to keep rates unchanged although markets expect no action from the Fed today with 90% certainty. However, they do expect a more hawkish statement and press conference. The likely path forward is that Yellen & Co. lay the groundwork for a June rate hike and let the markets digest and prepare for that.

“What If?” – Focus on the Banks

If Yellen pulled a March surprise, stocks, bonds and commodities should fall precipitously with staples, REITs, telecom and utilities being the hardest hit.

Of all the sectors, the banks look like they want to move most and here are four scenarios to watch for.

Fed stands pat & banks rally – Actionable trade for a few weeks to a few months

Fed stands pat & banks continue in line or worse with the S&P 500 – Ignore banks

Fed raises rates & banks rally – Actionable trades for the rest of the year

Leave Rates Alone

I won’t rehash my trail of comments since 2008, and you are probably tired of hearing and reading them anyway, but ever since Q4 of that year, I am on record as saying that the Fed should NOT raise short-term interest rates until the other side of the next recession. The U.S. survived the Great Recession, but our economy is far from thriving.

As I have also pounded the table for the past 7 years, we are living through a very typical post-financial crisis recovery which is very uneven and frustrating. It sometimes teases and tantalizes on the upside, but occasionally terrorizes on the downside. Think Japan since 1990. In the end, few are pleased with it and blame is easily fanned around.

The Fed has tried mightily to spark some “healthy” 2-3% inflation, but has not been successful overall. And I don’t believe they will see success until we get through the next recession which I forecast to occur early on in the next president’s watch. It should be very mild as corporations are sitting on roughly $3.5 trillion in cash with more than $2 trillion on bank balance sheets. It’s almost impossible to experience a significant recession with the banks having such a dramatic cushion of cash.

After that, inflation should begin a secular bull market along with interest rates going higher for decades. Our economy will finally get back to trend or average GDP growth of at least 3% which has not been seen since pre-2008. This could also coincide with Europe getting its fiscal act together after another sovereign debt crisis.

Did Yellen REALLY Want to Set Precedents
The December rate hike sets all kinds of precedents.

  • First rate hike ever with inflation under 1%.
  • First rate hike ever with the annual social security COLA at 0%.
  • First rate hike ever with wage growth needing to jump 100% to hit the Fed’s target.
  • First rate hike ever with industrial production on the verge of recessionary levels.
  • First┬árate hike ever with GDP barely 2%.
  • First rate hike ever with inflation expectations close to 0%.
  • First rate hike ever with retail sales closer to recession than escape velocity.
  • First rate hike ever with non-farm payroll job growth continuing to decelerate.

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Fed Day Again?!?!

Boy did six weeks fly by!

Here we are again. At 2pm we will hear from the Fed that interest rates remain unchanged, but their economic outlook is probably on the positive side. I also expect a comment or two about China and then the laying of groundwork for a possible rate hike six weeks from now. I still do not agree with any rate increase, but it seems like it’s coming.

The stock market model for the day is plus or minus .50% until 2pm and then a mild rally. Given the sharp run into the Fed announcement, my Fed trend isn’t as powerful as it could have been.

Stocks continue to behave very, very well and the rally shouldn’t be over by a long stretch. As I have said each and every week since the August mini crash, don’t be surprised to see fresh all-time highs sooner than later.

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Market Behaving as Expected. Bottom Shortly.

In my last update, I opined that the Fed should not raise rates and that whatever they did, the market would end whatever move it was having and reverse in the other direction. First, I am glad that Yellen & Co. did not raise rates. That time will come, but it wasn’t last week. Second, stocks rallied nicely into the Fed meeting and in the moments after the announcement. However, it was the perfect “buy the rumor, sell the news” as stocks reversed sharply shortly thereafter and closed near the lows for the day. I totally dismiss that the market was disappointed by the Fed’s lack of raising rates. That’s preposterous. Stocks rallied into the announcement in the classic ” buy the rumor” trend. Friday was an ugly day for the bulls and after the typical post-weekend, feeble bounce on Monday, the bears are out in full force today.

None of this action should come as a surprise as I wrote about post-crash behavior many times here and in Street$marts. From its intra-day low on August 24 to last week’s peak, the Dow jumped roughly 1500 points, retracing about 50% of what it lost since its last all-time high in May. Stocks are now in the throes of the secondary decline to revisit the levels seen in late August. I expect that visit to be successful within a few percent and eventually lead to all-time highs again.

The stock market doesn’t look pretty now and I don’t expect that to change until after the bottom is reached over the next two to four weeks. There will be all kinds of reasons not to buy when it’s time. “The market has lost confidence in the Fed.” “China is having a hard landing.” “Global economic growth is recessionary.” And on and on and on.

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Market Reaction to Fed Announcement

The big lingering question regarding the Fed meeting after the decision is how to properly position portfolios. If you thought it was tough to get an edge on the rate decision, the markets’ reaction is even more so, which is why I would absolutely not advocate making wholesale changes ahead of the announcement. It’s one thing to flip a coin on the decision, but it’s a whole other thing to get the markets’ reaction correct as well.

The four possible scenarios are below.

Rate hike and rally
Rate hike and decline
No hike and rally
No hike and decline

Before pondering that, I saw a few Tweets that suggested Yellen could raise rates with dovish comments or leave rates alone and offer hawkish comments. And if the Fed doesn’t raise rates now, we will be having this same discussion before the December meeting. It’s enough to make you head spin!

Regarding stock market reaction, the very short-term sentiment indicators still have sufficient enough pessimism to support further upside. If I had to lean, that’s the direction the odds favor right now, but I certainly would not bet the farm on it. Good thing for me since I don’t own a farm!

The Fed trend also has a 70% upward bias for the day, but some of that fuel was likely used this week.

Should stocks spike higher on the news and follow through, I will view that as a selling opportunity rather than a momentum buying opportunity, which should be the minority opinion.

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