December 2018 Fed Meeting and the Markets
by the Curmudgeon with Victor Sperandeo
The Fed is likely to raise its benchmark Fed Funds interest rate by a quarter-point (25 bps) to a range between 2.25% and 2.5% at the end of their meeting on December 19th. The CME FedWatch tool, which is based on Fed Funds futures prices, had forecast over a 75% chance of a rate increase for several months. The Fed tool is currently down slightly at a 73.6% probability of a 25-bps rate hike.
On December 19th, Powell will likely say that the Fed is no longer on the one-rate-hike-per-quarter pace seen in 2017 and 2018. The Feds dot plot (too complicated to illustrate in this article) is expected to pencil in two hikes in 2019, down from three projected this past September. In the Feds end of December 2018 meeting statement, the forward guidance language stating the FOMC expects further gradual increases in the target range will almost surely be removed.
Why? Global growth is slowing precipitously, the U.S. dollar continues to rise and is at a yearly high (making it especially difficult for emerging market countries to service their dollar denominated debt), and stock markets around the world are tumbling (that really shouldnt matter as stock market stability is NOT a mandate of the Fed- only stable inflation and unemployment are). The Fed's final projections for 2018 will come as investors are rapidly souring on the economy and losing confidence that the Fed will keep hiking rates as global economic headwinds hit the U.S. economy (Germany and Japan are already in contradiction, while China growth is the slowest in at least a decade).
The latest Bank of America Merrill Lynch (BofAML) FX/Rates sentiment survey saw a huge change in opinions in just the last month. In November 2018, 32% of respondents expected higher rates and a flatter curve, but that number as of December has since tumbled to just 13%, with the majority of investors now expecting little changes to rates after Fed Chairman Powell's recent dovish commentary. Heres BoAMLs bar chart showing recently monthly survey forecasts on top and November on bottom.
Michelle Meyer, head of U.S. economics at BoAML, said Powell must sound reassuring without sounding hawkish. The key words will be caution, patience, risks and data dependence, Meyer said. The reduction in the Fed dots will be seen as a market-friendly capitulation and the market is already anticipating the move with current market pricing suggesting less than one hike in 2019, Meyer added.
When short-term yields on government debt pop above their longer-dated peers (an inverted yield curve), it is often a prelude to a recession. Therefore, the flattening yield curve is an important stock market concern. Its depicted in this chart from BoAML:
Market strategists are intensely focused on the Feds outlook for 2019, which will dictate whether the inversion seen in some parts of the yield curve becomes more pervasive. The U.S. 2 year/5 year and 3 year/5-year Treasury notes recently inverted, which stimulated much discussion of imminent recession. Meanwhile, the more important headline spread between the 2 year and 10-year yields -at 15 bps- is almost flat. Its very close to going negative for the first time since 2007.
"The real risk will be that the Fed doesnt change the dot plot, increases fed funds and sounds generally kind of hawkish," Ian Lyngen of BMO told Bloomberg. "That would be a surprise, because I think consensus is now a dovish hike. So if we get a hawkish hike (with no Fed dot plot change), it will flatten the curve even further," he added.
We think that if the Fed refuses to budge on its three rate hike forecast for 2019, with the median 2019 dot plot remaining at 3.1%, then the U.S. and global stock markets will plunge.
Victors Closing Comments:
If the Fed raises rates on December 19th, the U.S. stock market will decline another 5%. Be aware that the Plunge Protection Team (PPT) might step in to buy stock index futures or ETFs if the market were to fall fast and hard. The world economy is slowing greatly and headed for a global recession.
However, if the Fed does NOT raise rates as I expect, the stock market could experience a Santa Clause rally. Remember, we are in a bear market, so rallies are sharp and short.
Good luck and till next time
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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