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Fed Non-Decision Decision Reaction: Markets Move to Session Lows

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November 2, 2016

(Wednesday Post-Fed Decision) Did anyone not expect this outcome from the Federal Reserve?

As the Chicago Mercantile Exchange futures have long indicated, the Central Bank held interest rates steady in a range between 0.25% and .50%. Though it did not commit itself to a December rate hike, as it did a year ago, the Fed did note that inflation is edging higher.

“Inflation has increased somewhat since earlier this year but is still below the Committee’s 2% longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports,” the Fed statement said. “Market-based measures of inflation compensation have moved up but remain low.”

The Fed reiterated its stance from September that it was not raising rates “for the time being,” reiterating its data-dependent position on continuing to measure how well the economy was chugging along on the employment and inflation fronts. It added, however, that “the case for an increase in the federal funds rate has continued to strengthen…. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.”

The markets, which were already trading to the downside, moved into session lows after the announcement. Typically, that might indicate that traders were uncertain about when a hike might actually happen. A year ago, Chairman Janet Yellen made it clear that the Fed was very likely to step up rates in December, which, of course, it did. There was no such certainty in today’s statement.

The dollar held slightly higher before and after the announcement, while benchmark Treasury yields, which were gaining ahead of the announcement, slipped to 1.78%. The VIX, the market’s so-called fear gauge, climbed nearly 7%.

The statement also noted that inflation lingers below the Fed’s 2% long-term objective, but “is expected to rise to 2% over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook appear roughly balanced.

An interesting side note compared with the September decision: There were three dissenters then, but two today. Why? Analysts speculated that the turn in sentiment was based on what’s ahead, such as Friday’s important jobs number and a number of metrics between now and the December meeting. And then there’s the presidential election. If the markets react negatively to whomever is elected, that could change the direction that the Fed may be anticipating in December. (See below.)

S&P 500

FIGURE 1: HOLDING STEADY

 The S&P 500 (SPX), plotted here Wednesday on the TD Ameritrade thinkorswim® platform, stayed above key technical support levels of 2,100 leading up to the Fed announcement. Keep an eye on it. If it moves decisively below 2,100, the focus will shift to its 200-day moving average of 2,080. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Is a December Hike a Sure Thing? Not necessarily, according to some analysts. While the speculation for some months has focused on a Fed rate hike in December, a new line of thinking appeared to emerge late last week when it looked like the tables may be turning on who might next occupy 1600 Pennsylvania. In short, a Trump win may create chaos in the markets, according to Barbara Rockefeller, economist and president of Rockefeller Treasury Services.

“It won't be long before the commentators start asserting that a Trump win means the Fed will not act in December,” she wrote in a column in FXstreet.com. “The election is Nov. 8 and the next Fed meeting is Dec. 13-14, giving it five weeks to reconsider the near-promise. A lot can happen in five weeks.”

In her estimations, if Trump wins, which the markets have not fully appeared to have priced in thus far, the dollar and equities will tank while gold, that safe-haven asset, will rally, “perhaps testing the last high at $1,355.95” on July 8, she said. “Yields will fall, perhaps to catastrophically low levels, such as the 1.341% we saw on July 6. Inflation expectations will be out the window as a guiding factor.”

Should any of that happen, she sees the Fed standing pat again in December. Why? “Because taming disorderly markets is one of the Fed's mandates,” she said, noting that “markets are not expecting this outcome.”

Of course, market chaos is always an uncertainty and, as we've seen with events like Brexit and even past presidential elections, what happens one day could be nothing more than a memory a month later.  

Keep an Eye on SPX. Market analysts note that the SPX has been steadily losing its mojo since hitting its all-time high in mid August. The Fed decision, coupled with a smattering of other economic metrics and the presidential election may cause a knee-jerk reaction, according to Market News. “Tuesday was the first time since July 7 that the S&P has traded below 2,100,” according to the online publication. “If 2,100 gives way decisively, the focus will shift to the 200-day moving average, around 2,080 currently, and then the July 6 low of 2,074.02.”

Remember that traders may tend to pay closer attention to key levels like moving average, highs vs. lows, etc., when there is confusion or uncertainty. And the Fed always strives for neutrality and does not want to introduce something that will shake them one way or another.

But as we’ve noted before, the markets are not the economy, and the Fed is scrutinizing the economy, but what happens in the markets matters. And, of course, past performance does not guarantee future performance.

Fed Statement Side Notes. One of the other changes in today’s statement compared with September’s is that the Fed now sees household spending as “rising moderately,” rather than “growing strong.” At the same time, market-based measures of inflation compensation “remain low,” rather than moving up as noted two months ago.

While the Fed notes that the case for a hikes has strengthened, it added that it was waiting for “some” further evidence of progress, rather than just further evidence.

The dissenters this time around were Esther George and Loretta Mester, again favoring a .50% to .75% rate. Erick Rosengren was the hawk-turned-dove this month.

Good Trading,
JJ
@TDAJJKinahan

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JJ Kinahan

JJ began his career in 1985 as a Chicago Board Options Exchange...

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