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Here Comes the Fed: Are We in for Another Hawkish Hold?

Here Comes the Fed: Are We in for Another Hawkish Hold?

James Stanley,

Talking Points:

- The Bank of Japan made a change to their stimulus strategy last night, and we will discuss that in our Market Talk article on Friday. But for now we have another major Central Bank waiting in the wings with the September FOMC meeting a few short hours away.

- Central Banks have become one of if not the most important driver of prices in many markets, and today’s meeting from the Fed could carry large repercussions around-the-world. Of recent we’ve seen an even greater divide between market and FOMC expectations for near-term policy moves.

- If you’re looking for trading ideas, check out our Trading Guides. And if you want something more short-term in nature, check out our SSI indicator. If you’re looking for an even shorter-term indicator, check out our recently-unveiled GSI indicator.

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This September meeting from the Federal Reserve has been in the crosshairs of markets for some time now; and this is actually quite similar to last year, in which the Fed spent much of the summer sauntering towards a September meeting that carried a chance of a possible rate hike. But last year saw weakness from China permeate across global markets about a month ahead of that meeting, and the Fed appeared to try to straddle the line between hawkishness and dovishness by not hiking rates while warning that hikes were probably coming by the end of the year. And just like the fanny pack or the mullet trying to combine two great things that people usually like into one package that just doesn’t seem to work, risk aversion and equity weakness continued for about two weeks after that meeting until multiple Fed members talked up the prospect of ‘looser for longer,’ at which points equities began to show signs of strength again.

Last September’s Hawkish Hold Sent Stock Prices Lower

Chart prepared by James Stanley

That rally continued as we neared the December meeting in which the Fed posed the first interest rate hike in over nine years; but while doing so they also shared their expectation of a full four interest rate hikes in 2016, which was a bit of a stretch for a Central Bank that just went through considerable discord in the previous few years to get through a single 25 basis point hike. Two weeks after that first rate hike in nine years and aggressive risk aversion had, once again, taken hold.

This lasted until mid-February, at which point Ms. Janet Yellen took a concertedly dovish stance during her twice-annual Humphrey Hawkins testimony. On the first day of that testimony, when asked about the possibility of negative rates, Ms. Yellen responded that the Federal Reserve had questions on the legality of such a policy. This alluded to the fact that the Fed may be running out of policy tools, and this only drove risk aversion more aggressively. But on day two of that testimony, when responding to the same question of the possibility of negative rates, Ms. Yellen was considerably more open in saying that the Fed wasn’t going to take any policy option off-the-table; and this alluded to the prospect of even more action from the Federal Reserve should risk aversion continue, and this helped to solidify a foundation of support in the risk trade that lasted through much of the summer.

The Fed Came into the Year Very Hawkish, but That Changed Quickly

Chart prepared by James Stanley

But as stock prices re-ascended to fresh near-term highs, the Fed began to get a bit more hawkish. At the April FOMC meeting, the Fed indicated that they felt markets were underpricing the probability of a hike at their next meeting in June. And for much of May the US Dollar strengthened while stocks faced selling pressure. But the Non-Farm Payrolls report released on June 3rd helped to extinguish those hopes/fears of a rate hike after an abysmal print; with the apparent logic being that if the Fed has been so passive towards tighter policy in the past, they likely wouldn’t be hiking rates after a shockingly bad jobs report, even if it was just for a single month.

Again in July we saw the Fed make a slightly-hawkish tweak to their statement, and this time markets didn’t really begin to incorporate that theme of a stronger US Dollar on the prospect of tighter monetary policy until later in August; where, at the Jackson Hole Economic Symposium, a chorus of Fed members talked up the probability of a rate hike in September, key of which was commentary from Chair Yellen and Vice Chair Stanley Fischer.

But again, as we had seen in early June, early September brought weak US data that saw markets reverse those rate hike hopes/fears under the presumption that the Fed wouldn’t be hiking rates in the face of slowing data; even despite the prior comments given not more than two weeks earlier from Ms. Yellen and Mr. Fischer. But the selling in USD didn’t last for long, as follow-up comments from even more Fed officials denoted a hawkish tilt for this upcoming rate decision; and as we near this widely-awaited meeting the US Dollar is sitting near short-term highs as seen below.

U.S. Dollar Bouncing Around of Recent on FOMC Commentary

Chart prepared by James Stanley

So today’s meeting is a bit of an abnormality given recent patterns as multiple Fed members have talked up the prospect of a hike later today, but market probabilities for an actual hike in September are at a meager 15%.

This leads to the logical conclusion that today could be a prime opportunity for the Fed to try another ‘hawkish hold’ scenario, in which the bank holds rates steady while talking up the prospect of a hike later in the year. When they did this last year, markets responded aggressively out of fear; but more recently it appears as though hawkish Fed commentary is bringing a diminishing marginal impact to markets.

The questions to be answered today are a) what is the Fed’s outlook for December regarding near-term rate hikes and b) how do markets respond to this announcement. Should the Fed stay hawkish for December, we may be in for a delayed response in risk aversion as markets have seemingly come to expect the Fed to stay loose and passive. But should risk aversion be seen quickly after any hawkishness, we’re likely in for some element of capitulation from FOMC members, similar to what was seen around the end of last September; giving another burst of life to the risk trade.

--- Written by James Stanley, Analyst for

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