Everyone Knows What This Week's Fed Meeting Will Bring ... Or Do They?

The Fed will start their meeting today, and everyone seems to think they know what’s coming. There will be no rate hike, and stocks will move higher. The first part looks just about certain, the second, not so much.

At the end of last year and early this, the FOMC members -- the central bankers who essentially control U.S. monetary policy -- began to indicate that they were going to change direction. They let it be known that the rate hikes that had characterized the last couple of years of Fed action were coming to an end, at least for now.

Of course, they said that fit with what they had always said, that decisions on rates were “data dependent.” With inflation still low, however, some cynics suspected that they were caving to pressure, either from traders, who had caused a rapid 20% drop in stocks, or to Twitter-trolling from high places.

I prefer a less world-weary explanation.

While inflation matters, the FOMC has been focused on the labor market for a long time and as tightness there began to show itself in terms of wages, they decided that a hiatus of some kind could do very little harm and could avert a potential problem.

Whatever their reason though, they have made it pretty clear that there will be no hike this quarter, and that caution will reign for the rest of this year.

That is why, as puzzling as it is given the global situation, stocks are booming. The unholy mess that is Brexit, the virtual admission by the ECB that the Eurozone economy is in trouble and the fact that, despite constant assurances that a deal is imminent, trade talks with China remain unproductive would, under normal circumstances, put pressure on equities.

These are not normal circumstances.

They have not been for ten years. Once the Fed decided to enact unorthodox and previously untried problems to counter the credit crisis-driven recession, we entered a kind of twilight zone for the markets. Nobody really knew what the effects, short or long term, of those policies would be, but one thing looked sure: Such massive injections of cash and such a strong market presence from the central bank would distort markets somehow.

To this point, given where we were and what the economy and the market have done since 2009, it is hard to argue that those policies have been anything but a success. The problem though was always going to be how to end them. A pause in the exit process such as is currently being signaled gives the market hope that that transition can be accomplished successfully and prompts some serious buying.

The problem though is that history, and the chart below, shows us that significant market moves in anticipation of a Fed meeting are often reversed when the meeting ends.

The last three quarter-ending Fed meetings, marked by the blue arrows on the chart, have marked turning points in the market’s fortunes and that is probably not a coincidence. The Fed’s actions are so critical that anticipation of a decision reaches fever pitch as one approaches, making a “buy the rumor, sell the fact” effect just about inevitable. That is especially true given the inherent conflict between what the Fed does and why they do it.

This time around, for example, the buying is because a pause in rate hikes is seen as a positive for stocks. The problem, however, is that in order to avoid charges of being pressured by traders or politicians into an action, a policy reversal has to be explained. That is easy enough: all Jerome Powell has to do is point to weakness in the U.S. and global economies severe enough to present a real risk.

That is easy, but dangerous. Traders and investors have become accustomed to hearing from the Fed that things are going great. Hearing that they aren’t could be a shock to the system and may shift attention to the potential disasters lurking overseas.

While it is true that slowing the pace of rate hikes and balance sheet reduction are probably appropriate at this juncture, this looks like a Catch-22 for the stock market. If Powell disappoints by signaling a return to hikes before long, the market drops; if he doesn’t, it has to be explained and the explanation will most likely sound like a grim picture for the economy. Either way, while everybody thinks they know what to expect this week, the reality in terms of market reaction still has the capacity to surprise.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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