Why No Rate Hike Is Predictable But The Market Reaction Isn't
Usually the most dangerous time in financial markets is when it seems that everybody agrees. Trading and investing involve having a view and then positioning yourself to take advantage if that view is correct. The obvious problem here is that if everybody has the same view and positions, there is nobody left to react when events unfold as predicted.
That leaves little room in the anticipated direction, but can cause a huge move against if there is any hint of something different. That is the basis of what is known as “buy the rumor, sell the fact.”
It isn’t hard to see that this is the position we are in today as we wait for the Fed’s decision on interest rates and the subsequent press conference from Chair Janet Yellen. Everybody now agrees that there will be no rate hike this month. That seems to be a reasonable assumption given the weak jobs number for last month and a much larger than expected fall in industrial production according to figures released this morning.
If that is the case, though, it doesn’t necessarily mean that the stock market and commodities will surge higher as you might expect. In part that is due to the buy the rumor, sell the fact effect, but it is also due to the reasons for the delay in moving.
The Fed has made it clear on many occasions that they want to “normalize,” both in terms of a return to moderately positive interest rates and a smaller balance sheet, so a delay in that process must be explained, and that explanation is unlikely to be pretty.
If Yellen says, as I suspect she might, that the delay is due to deteriorating economic conditions and slowing growth in the U.S., but that the FOMC intends to raise rates as soon as conditions improve, it will be a double whammy for markets.
Not only does that suggest that a collection of smart economists with access to a lot of data feel that the economy is weak, but also that if it improves they will immediately take action likely to tamp it down again. The near future, in other words, is bleak however you look at it.
Don’t get me wrong, I don’t think the Fed has any choice here. It could be that the recent rash of weak numbers is just an anomaly; a slight drop, not unusual in a recovery period, that will quickly be smoothed over in moving averages. That could be the case, but the FOMC cannot afford to assume that it is.
If this really is the beginning of a sustained downturn, then raising rates, even by only 25 basis points (that’s a quarter of a percent if you aren’t fluent in bond speak) would simply add fuel to the fire. If not, one would think that delaying by a month or two cannot hurt too much.
There is some evidence, though, that time is not a luxury that the Fed has too much of. In addition to the disappointing numbers mentioned above, there has been one other data point released this morning that further complicates the issue. Producer Prices rose by 0.4 percent last month, more than the 0.2 percent that was expected, indicating that inflation may not be too far away. In small doses that is not a bad thing, but the last thing the Fed, or anybody else for that matter, wants is for that to take hold.
It is likely then that the news this afternoon will be full of mixed messages. A rate rise is unlikely, but so is tough talk of hikes to come. When that is combined with worrying reasons for the delay it seems that any rally on a “no hike” announcement will be extremely short lived.
Staying away until things are clearer makes the most sense, but if I were forced to take a position I would probably short oil or maybe stocks. Everybody agrees there will be no rate rise and, by extension that those markets will jump and that alone is good enough reason to take the opposite position.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.