Thursday, February 2, 2017

Fed Won't Raise in March

The Fed has been very careful raising rates since it launched the first one in 2015.  Although they are being more aggressive with their rate hike talk, let's not forget their history of forecasting rate hikes and not delivering.  They forecasted 4 rate hikes in 2016 at their December 2015 meeting, and they delivered 1.  They forecasted 3 rate hikes in 2017, and the question is how many will they deliver?

It seems like the financial pundits have finally caught on to the dovish pattern and most expect 2 rate hikes, some expecting 3.  I am expecting 1.  The reasoning is the following:  Unless the Fed is completely certain, they will delay their hike by 3 months.  They did that in September 2015 and 2016.  They delayed their taper in September 2013, pushing it out to December.  And guess what?  There is a debt ceiling in middle of March, right before the Fed is set to meet.  Then there is a good probability that we will have a pullback before their March meeting.  Also, there is the always lame political uncertainty excuse, which they pulled out before Brexit and before the presidential elections.  Don't be surprised if they pull that out before Trump sets his economic policy and before French elections.

Yesterday, they didn't hint strongly of a potential rate hike at the next meeting like they did before previous hikes.  That pretty much takes March off the table. They don't hike rates in their non press conference meetings.  They might change that this year, but it is going to take a really strong stock market to do so.   I doubt that happens, since I believe we are replaying 2015.  So that gives them 3 shots at raising rates in 2017.  But if you remember 2015, we took a plunge in August, on China devaluation fears.  And China is in much worse shape now.

So 2017 definitely has a good probability of a swoon between now and September meeting, which means if things don't correct before June, you can raise once in June, and then the market weakens and corrects, and you take September off due to the stock market going down.  At that point, you have one last shot for a double rate hike year, and that is December.  Who knows where the stock market will be at that point, but I believe it will be lower than here.  I don't see them pulling the trigger in December unless Yellen wants to decrease the likelihood of her reappointment in Feb. 2018 from 40% to 1%.  She desperately wants to outlast Trump, and she will probably have to agree to some favors (1 rate hike max in 2017) at a one on one meeting in order to have any chance of keeping her job.  And even if she delivers her promise, Trump may fire her anyway.  That is his style.

We are stuck in this low volatility chop.  Don't be fooled by intraday weakness.  We are trading right around the median of 2017 SPX levels.  We have gone nowhere, and I will not interpret that as bearish.  Or bullish.  As for bonds, it is notable that we got stronger economic data yesterday and the Treasuries dipped but rallied back to nearly unchanged after the FOMC meeting.  There is a lot of resistance around that 2.50-2.52% 10 year zone.  I believe it will eventually crack, but we probably see a bit more chopping around at lower yields before we breakout.

Why do I believe we breakout to higher yields?  Mainly because of two reasons.  The ECB will have to consider tapering because they are running out of Bunds to buy.  Unlikely that they mention that ahead of French elections, but I highly expect that to be in the news often after the French elections.  Also, Trump is going to start talking about his massive tax cuts soon, and that is going to make bond traders nervous.

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