Fed time; Groundhog Day

September 21, 2016 09:57 AM

To say that it is time for the Federal Reserve’s Open Markets Committee (FOMC) to raise interest rates later today would be almost meaningless at this point. When the Fed finally pulled the trigger last December, we thought it may put the end to all this speculation.

See, when the Fed finally began tapering from quantitative easing infinity (QE3), they did so in an orderly fashion and continued to reduce its bond purchases on a consistent basis despite positive and negative news. So when the Fed tightened the first time there was an expectation of the same. The Fed’s own dot plot suggested four rate increases in 2016 was possible (every other meeting) but the market (Fed fund futures) has priced in a more modest two increases for the year.  Fed Chair Janet Yellen in her press conferences had intimated that this was likely the plan.

When it was apparent the economy slowed down in the first quarter, the two increase scenario seemed more likely. So the Fed’s caution was consistent with their pronouncements and market expectations, up until the June meeting. For some, they get a pass in June due to worry over the Brexit vote, which once the markets calmed down allowed a small expectation for a July increase. When that didn’t happen, most analysts assumed there was a change in policy, even though there was no official pronouncement from the FOMC. In fact, as the Fed disappointed the hawks at each meeting, the hawks within the Fed would continually suggest a move was coming.

This takes us to today’s meeting. While most pundits had assumed the Fed had changed policy, a combination of strong jobs numbers and hawkish pronouncements from FOMC members, led to a growing consensus that the Fed would indeed tighten today. An economist from Goldman Sachs had even called for this. Which takes us to Friday Sept. 9 when the S&P 500 dropped more than 60 points. This was no doubt the market pricing in the now consensus notion that the Fed would act.

Of course, this has happened before: Protest sell-offs in the face of a potential tightening. It seems crazy to me that the Fed would tee-up a rate increase—as they have done a couple of times—causing a market sell-off, only to lose their nerve in the face of increased volatility. You already pay the price of a move and then lose your nerve and hold off ensuring another sell-off the next time.

The Fed is beginning to look like the proverbial “Boy who cried wolf.”

Making matters worse is the fact that Presidential candidate Hillary Clinton collapsed the following weekend, perhaps giving some validity to what previous was considered conspiracy theories regarding concerns over her health.  Now the Fed is supposed to be neutral on politics but given their love of certainty and the unpredictability of all things Trump, it would not be a stretch to assume that many FOMC voting members would prefer to see Clinton elected. In fact, another argument against a move is that it would be inappropriate for the Fed to move rates so close to an election. While perhaps that would be true in a normal environment, this is not a normal environment—the Fed kept rates at zero for seven years, finally moving last December with the expectation of gradual increases. They have even lost that expectation as many analysts don’t believe they will act in 2016, and assume we are in a holding pattern. This “not now, but next time for sure” attitude is getting old.

But back to politics, if we assume there may be some in the Fed preferring to see Clinton as our next President, it would be wrong to assume a 25-basis point move today (or even a smaller moving locking in a 50-basis point target) would be negative to her campaign. Sure there might be a sell-off, though a huge “buy the rumor sell the fact” type rally would be a distinct possibility. However, the larger point is that the Fed has been championing this economic recovery since it began. It is hard to claim we have a solid economic recovery while keeping rates frozen in a range of 25-50 bps for an entire year; after not moving for eight years. A rate increase would be a net positive for Clinton.

Today there is a consensus that the FOMC won’t act despite the fact that 12 days ago there was a growing consensus that the Fed would tighten. There has been no significant economic numbers that would justify this shift, only a scary sell-off.

I figure the odds at about 50/50. There also has to be the realization within the FOMC that they are beginning to look somewhat comical. The only way for them to address this growing perception would be to act and raise the Fed funds target. 

About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.