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Fed Reaction: Stocks Mixed as Rate Hike Could Still Happen in 2015

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September 17, 2015

Stocks were jostled in the immediate wake of a no-action Federal Reserve meeting. The panel left key lending rates unchanged, but some members signaled a hike could come yet this year depending on the economic data.

With today’s inaction, short-term Fed funds lending rates still stand at zero to 0.25 percent. And with that, the Fed said: "The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad. Inflation is anticipated to remain near its recent low level in the near term but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissipate.”

Here’s an interesting nugget: The median of the Fed's long-term forecast was lowered to 3.5% from 3.8% in June. The Fed is forecasting a Fed funds rate of 0.4% for 2015, 1.4% in 2016, 2.6% in 2017 and 3.4% in 2018, which all are lower than the central bank saw in June. That would seem to argue that the Fed currently expects a slow approach to unwind easy monetary policy.

No Rest for Volatility

For traders, it looks like we can finally get back to truly "trading” now that the big unknown of this particular meeting has come and gone. Still, stock market reaction is particularly hard to pin down for today, tomorrow, and the coming weeks because this is an unprecedented time for global stock volatility running smack up against what was an already pretty critical Fed decision. Fed clarity today and in upcoming speeches and meeting minutes will be important to stock investors.

Not all may like the Fed's plan with interest rates but if it's clear what and why the Fed is doing what it's doing, it will be an easier pill to swallow for the broader market. After all, the Fed will want to avoid leaving an impression that it's been knocked off its game, risking falling behind in removing what really was "emergency" monetary policy post-recession.

Whether the Fed raises interest rates this year or next, there's little doubt that stock volatility could remain elevated the rest of the year. And what I mean by "elevated" is the CBOE Volatility Index—the VIX—would run closer to its historical norm near 20. A 20 reading, which had been the long-running threshold that divided relatively calm markets from highly volatile markets, will feel elevated simply because VIX had been uncommonly low. Remember, VIX ran well below 15 for much of this year, and flirted with a dip below 12, before the August pullback for stocks.

And For the Long Term?

Some analysts could argue that there's a long-term bullish case for stocks even with a rate hike. Those analysts will lean on the fact that an improving hiring picture and stronger housing market will continue and that low inflation readings could allow the Fed to stick with its desired go-slow approach to rate hikes. U.S. shares generally have dropped as much as 12% in the last month, and a post-Fed share decline, if it happens, could simply make long-term buys more attractive for investors taking that approach. Want a little history? The S&P 500 (SPX) has fallen in immediate response to the start of a Fed tightening cycle in three of the past five instances. It logged an average directional move of 1.4%.

It’s clear that the bond market is readying for higher rates—at least at some point. Yields (aka interest rates) on two-year Treasury notes shot up to a four-year high earlier this week.


Experts Discuss Fed's Market Impact

Find out how rising interest rates might impact your portfolio. Watch the webcast replay from September 15, featuring TD Ameritrade's JJ Kinahan, for perspectives on stocks, and Craig Laffman, for perspectives on fixed income.


stocks-move-on-Fed

FIGURE 1: PRE-FED POSITIONING.

The S&P 500 (SPX), charted above, has held 1950, and in Wednesday’s session, made a charge near the psychologically significant 2000 line. Data source: Standard & Poor’s. Chart source: TD Ameritrade’s thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Good trading,
JJ
@TDAJJKinahan

NC
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