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Waiting Game: Fed Not Seen Raising Rates, But Will Yellen Provide Insight?

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June 15, 2016

(NOTE TO READERS: JJ Kinahan is traveling, so the following is a guest Market Update column written by Kevin Hincks, Sr. Specialist, Trader Education Host, and Swim Lessons host. Swim Lessons is trader educational programming, which TD Ameritrade clients can access live beginning at 10:30 a.m. CT each trading day from the Support/Chat function within the TD Ameritrade thinkorswim® platform).

(Wednesday Market Open) Fed day is here, but there’s little expectation of a rate hike. Instead, speculation centers on what the Fed may say about the economy and possible future rate strategy.

Questions continue to boomerang around the markets ahead of the Fed’s 2 p.m. ET announcement, with volatility rising over the last week amid a worldwide flight to safety. Fed Chair Yellen’s press conference is scheduled for 2:30 p.m. ET.

Are Fed officials, including Yellen, still concerned about the possibility of higher wages leading to inflation, which would potentially need to be addressed with rate hikes? They seemed to feel that way a few weeks ago, but the anemic May jobs number raised questions about whether strong wage growth would continue. So the question is, will Yellen still say interest rates should be raised, and indicate by when? The key thing to watch is Yellen’s tone, and whether it changes from her recent hawkish stance to a more dovish one based on the jobs data.

And will the Fed have anything to say about the recent plunge in overseas and U.S. bond yields, which many analysts say reflect a “fear trade” ahead of next week’s scheduled “Brexit” referendum in which British voters will decide whether or not to stay in the European Union? Considering the premium U.S. Treasury yields hold over European and Japanese yields, which are near zero or below, does the Fed still feel two rate hikes are necessary this year, as it indicated not so long ago? Many analysts expect Yellen to be asked about Brexit and its potential effects.

And what about the Fed’s calendar going forward? There’s no press conference scheduled for the July 26-27 Fed meeting, and typically the Fed raises rates at meetings where a press conference occurs. If Yellen mentions the possibility of a press conference taking place at the July meeting, the market might take that as a sign that the Fed is preparing a rate hike that month. The odds of a July hike stand at 24%, according to Chicago Mercantile Exchange (CME) futures. That compares with 4% odds for a hike today. Possibilities don’t rise above 50% until the December meeting.

One thing investors do know: There’s still a long way to go and a whole lot of data to digest before the July meeting, including another Non-farm Payrolls report early next month. The Fed will have an entire month of data between now and late July to make its decision. All year, the Fed has said it would let data be its guide, and another weak jobs report next month could be a factor if the Fed decides to hold off once again.

Another factor the Fed seems to be taking into account is market volatility, which surged over the last week. Some analysts say the Fed is unlikely to hike rates when volatility is high.

It’s not all about the Fed today. The government released its May Producer Price Index (PPI) data this morning, showing a 0.4% rise compared with expectations for 0.3%. Industrial production and Empire Manufacturing data are due later.

On the commodities front, the International Energy Agency (IEA) said Tuesday the world oil market is now in balance after production had outpaced demand for much of the last two years. It credited recent outages and strong demand. But it predicted a surplus again by early next year. Oil has come under pressure this week from Brexit concerns, and U.S. crude futures fell to three-week lows early Wednesday below $48 a barrel. The U.S. government provides oil inventory data at 10:30 a.m. ET today, and that follows Tuesday’s industry inventory data that showed a surprise 1.5 million barrel supply build. More insight is due Friday with the weekly rigs count report.

S&P 500

FIGURE 1: TECHNICAL SUPPORT BREACHED.

The S&P 500 (SPX), plotted through Tuesday on the TD Ameritrade thinkorswim platform, fell below technical support at the 50-day moving average of around 2076, but finished well above the day's lows. Sometimes a strong finish can translate into strength the next day. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Retail Sales Provide Alternate Take on the Economy: Nearly two weeks ago, the U.S. government delivered something of a shock in its May Non-farm payrolls report, showing just 38,000 jobs created. That report caused some re-thinking about the economy’s health after several positive economic reports in May. But Tuesday, the government’s May retail sales report appeared to indicate a healthy consumer, with retail sales rising 0.5% during the month, above expectations for 0.3% growth. Remember, consumer spending composes two-thirds of the economy, so retail sales is an important indicator. In the long run, Tuesday’s retail sales are just one number, but they’ll be part of a list of data the Fed is likely to look at when it meets again in late July, including inflation readings and next month’s jobs report. That means plenty of chances to try to figure out if the June employment report was an outlier or indicative of gathering storm clouds.

Volatility, But For How Long? One question that may be on some investors’ minds is how long the current market volatility can last. Certainly this week’s Fed meeting, today’s Bank of Japan meeting, and next week’s Brexit votes all helped play roles in driving the VIX market volatility indicator to three-month highs Tuesday. But once all this static clears, does the rest of the month look like a quieter time? Common wisdom is that markets dislike uncertainty, and a lot of that uncertainty could be out of the way after the Brexit vote Thursday. By then, the U.S. will be approaching the July 4 holiday, traditionally a more relaxed period in the markets as many leave for vacation. The VIX is currently in what traders call an “event market,” and is likely to come down after the event happens. However, if Britain votes to leave the European Union, the week leading up to the holiday may be less than relaxing. And in addition, the monthly U.S. jobs data will be looming early next month. Perhaps the rough ride isn’t over.

The Pound Keeps Sinking: With Brexit just over a week away and some polls indicating voters may decide in favor, the British pound fell below $1.41 on Tuesday, the lowest level since early April and another test of technical support at $1.40. The pound is down more than 17% against the dollar over the last two years, and much of the weakness seems Brexit-related. Some economists predict a sharp drop in British gross domestic product (GDP) if voters decide to exit the E.U., but it’s important to keep things in perspective. The main reason Brexit would conceivably hurt the British economy is because Britain could lose the special trading status it enjoys with other E.U. nations. But that wouldn’t happen immediately, and it would probably take at least a couple of years for the full impact on trade can be determined. Indeed, the pound could potentially make a comeback against the dollar even if Britain votes to leave, simply because uncertainty would be out of the way, some analysts say. Still, it seems like this wouldn’t be a bad time for Americans to plan a trip to England if they want to get some bargains in Knightsbridge.

Good Trading,
Kevin

Economic Calendar

FIGURE 2: THIS WEEK'S ECONOMIC CALENDAR

Source: Briefing.com

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Kevin Hincks

Kevin Hincks is the co-host of “Swim Lessons,” the show heard daily on the thinkorswim® platform from 10:30 a.m.–noon CT.

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