The Federal Reserve’s failure to raise interest rates at its last meeting has resulted in the credit market projecting that the next interest rate hike won’t occur until December of 2017. Back and forth we go… and now we have a dovish Federal Reserve.
By failing to raise rates, the stock market responded as if the Federal Reserve has cut interest rates. In other words, when the Fed reversed course and signaled easing in their ‘dot plot’ changes it had the same impact of a country de-valuing its currency.
The US stock market took off and has rallied to back within a few percent of its all-time high. Commodity-related stocks have led the way. At the same time, treasury bonds have held their own. So the main question we have to answer is whether this recent stock market rally is a new trend that will last several weeks/months longer or is it a temporary counter-trend in an overall declining economy?
The research that I do on a daily basis (both economic and quantitative) continues to support the view that the economy continues to slow. China’s troubles are escalating. The dovish US Fed is causing pain in Europe and Japan and threatens to drive their economies into recession. And growth here in the US continues to disappoint.
Normally, central bank actions unfold over a longer period of time. They move slowly and do everything they can to telegraph their actions so as not to upset the markets and give the market participants the time to adjust. In December they announced that they would raise interest rates and embark on a path (per the Dot Plot) of continuing to raise rates 25 basis points for the next several meetings. If you remember, that caused the US stock market to drop 12-14% in January and the first half of February.
That’s why it was such a surprise when at the next meeting the Fed drastically did a U-turn. Not only did they not raise interest rates, they completely reversed course and signaled in their Dot Plot that there wouldn’t be any rate increases for an extended period of time. From a hawkish to dovish Federal Reserve in weeks.
That statement is akin to driving on the interstate at 70 mph and suddenly throwing the vehicle into reverse! The result was the stock market took off and rallied back up near the all-time highs of last July.
Here’s the problem, though. The stock market has already rallied based on the Fed easing. And since the market has already factored in a dovish Federal Reserve, what is going to cause the markets to go higher from here? Earnings season has already begun and it is expected that this could be the third time that companies will show negative quarterly sales and profits. Some are speculating that the US economy may already be in recession. Besides, has anyone realized that there was a reason why the Federal Reserve reversed course so quickly? They have been telling us for over a year that everything is fine—strong economy! Most of us knew that wasn’t the case; and the data coming out since then has made it harder for them to continue the charade without losing what is left of their credibility.
In full disclosure, I continue to own US Treasury bonds and am short the general market indexes. The markets may rally for a few more weeks but it is hard to overcome economic gravity forever.
— WSJ News Graphics (@WSJGraphics) April 20, 2016
Thanks for reading.
The author holds positions in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.