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Major Fed Scenarios

FED 123

This week all eyes and ears will be focused on the Federal Reserve's policy statement to be released at 2:00 pm ET Thursday. The Fed has three major paths they can take, with various permutations and combinations flowing off the base scenarios:

  1. No change to interest rates, but a much more hawkish statement hinting "we are raising rates before the end of the year. It is coming, so get ready".

  2. A small increase in interest rates accompanied by a "we plan to move very, very slowly going forward" statement.

  3. No change in rates and no significant change to the "it is data dependent" statement.


Which Way Is The Market Leaning?

Markets make decisions based on the data in hand and based on future expectations. Obviously, the Fed can change the data in hand, which in turn can change expectations. Having said that, what is the market's current read heading into the Fed decision? For the answer, we review numerous risk-on vs. risk-off ratios in this week's stock market video. The charts speak for themselves.


Why The Fed Will Not Wait Indefinitely

Whether or not the Fed hikes this week probably falls into coin-toss territory. At first blush, it seems reasonable to ask "what is the big hurry?". The Fed's concern is not about current inflation, but rather future inflation. From Bloomberg:

Fischer, whom Fed Chair Janet Yellen has said she relies on in mapping out policy, made a similar point much more recently. "There is always uncertainty and we just have to recognize it," he told CNBC television on Aug. 28. Asked if the Fed should delay an increase until it had an "unimpeachable case" that a move was warranted, Fischer replied, "If you wait that long, you will be waiting too long." Fischer made much the same point at Stanford University on March 14, 2014. "We tend to underestimate the lags in receiving information and the lags with which policy decisions affect the economy," he said in a speech, titled Lessons from Crises, 1985-2014. "Those lags led me to try to make decisions as early as possible, even if that meant there was more uncertainty about the correctness of the decision than would have been appropriate had the lags been absent," he added.


Investment Implications - The Weight Of The Evidence

What flavor of statement will come across the wires Thursday afternoon? More importantly, how will the market react to the statement? The number of statement and reaction combinations is almost infinite. Therefore, our approach will be to monitor and adjust if needed, rather than anticipate and hope.

The facts in hand are not attractive from a risk vs. reward perspective. The markets can begin to improve at any time. However, we need to see meaningful improvement; something that has not happened yet. We will maintain a defensive posture; respecting things can evolve quickly once the Fed has made their intentions known.

 

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