Today, (Wednesday) the FOMC makes their announcement regarding rates. After this month’s weak payroll report, the market significantly cut the odds for a hike at any time this year. The quarterly FOMC meetings come with a press conference, and though some Fed officials have vocally called for rate hikes, Yellen is likely to adopt a cautious stand for the foreseeable future. The Fed’s risk management model is such that it weighs the costs/benefits of staying put versus raising. The risks of holding rates at the current low rate are these: 1) pockets of excessive speculation may increase, causing some instability, 2) inflation may start to accelerate and 3) the Fed wants/needs ammo in case conditions turn down again. None of these factors are compelling currently.
Let’s consider market clues that may cause the Fed stay put. 1) Employment numbers have been showing signs of deceleration. 2) the Brexit movement has gained in the polls, representing a risk of international instability 3) banking stocks in Europe have been crushed to new lows, for example Deutsche Bank, Credit Suisse and UBS all made new lows yesterday 4) the US yield curve continues to flatten, indicating slow growth and low inflation expectations 5) international risks aren’t only due to Brexit, the Chinese yuan (CNY) is making new lows (recall that the August yuan devaluation sent global stocks into a tailspin) 6) investors are seeking safe havens. For example, gold is near a new high, ten year US treasury yields are at a new low of 1.61%, the German bund traded below zero, and bitcoin has simply exploded, gaining 50% in the past MONTH. 7) VIX has jumped over the past few sessions, from 14 to over 20. The Fed, especially now, simply will not want to rock the boat over the short term, and that could easily mean through the rest of the year.
Having said that, it is not at all clear that the removal of some of these risks (for example a “Stay” vote by the UK), will give an ‘all-clear’ signal for risk assets. In the short term, there could easily be relief rallies. But the longer term problems of the European Union have been more fully exposed by the Brexit vote, and China’s problems still appear to be festering. It’s a difficult environment in which to envision new highs in stocks or other risk assets.
Alex Manzara
