MorningWord 12/15/14: Don’t Fight The Fed Week $SPY

by Dan December 15, 2014 9:44 am • Commentary

Let’s remember that green openings after large down days can be precarious. Especially when you consider we are two and half days away from a catalyst that has the potential to turn the tide in global equity markets (sorry I am not sure there is anything that can turn it in commodities). The Fed’s rate statement Wednesday afternoon is the main event this week (and maybe for the rest of the year), and your guess is as good as mine whether or not they remove their low rate pledge for a “considerable time”.  And your guess is as good as mine on how equity markets take the news.  Put it this way, if the the Fed strikes a more hawkish tone it shows confidence in the Jobs & GDP recovery despite few signs of increasing inflation. It would show their confidence in the U.S. economy’s ability to “go it alone” and essentially de-couple from almost every other major economy in the world (China, Japan, Brazil, Russia and Europe). Regular readers know where I stand on the whole “de-coupling thesis.”

But let’s think back to 2007/2008 when U.S. equities had topped out In late 2007, yet the price of crude oil continued to rally 30% until it topped out July 2008.  The move in the first half of 2008 was largely predicated on the notion that emerging market’s growth would be largely unaffected by any sort of U.S. domestic real estate and banking crisis.  We know how that one ended. Badly, and Crude dropped 75% from the July 2008 highs to the lows in early 2009:

Crude Vs SPX 2007 to present from Bloomberg
Crude Vs SPX 2007 to present from Bloomberg

Are we now seeing the opposite? Crude topped out in late 2013, and U.S. equities rallied more than 25% up until last week’s all time high.

Given the external factors that the Fed (or anyone else for that matter) barely has a handle on, specifically WHY industrial commodities are crashing, Ms. Yellen and her colleagues at the FOMC are in a fairly impossible spot.  But I think it is important to remember that just because the Fed signals that they are on track for a mid 2015 rate hike, the bond market will have the final say. As it has in 2014, with the 10 year U.S. treasury yield having dropped precipitously from the January highs of about 3% to 2.1% on Friday.  Market participants are at least for now thinking lower for longer on the rate front, regardless of a few sentences in the Fed’s rate statement.

So if the Fed were to hint a more hawkish stance through language change then the question you have to ask yourself is are they about to muff things up? Are they about to misread the how and why as they did back in 2007/2008? Is there a potential contagion this time around like our sub-prime crisis last time? I’m not saying there’s anything that catastrophic possible. That turned into a full blown banking crisis with the effects still being felt in some parts of the globe. But it’s possible there’s a monster at the end of this book on a much smaller scale.

If the Fed remains vigilant with their zero rate policy does it signal that the global economy still too shaky? That would be despite the fact that the baton has been passed with China and Japan easing and the ECB waiting in the wings.

Those questions will power risk assets one way or the other in 2015. But for now, trading into and out of the Fed, I suspect we find our footing prior to the rate announcement and rally into it, as we have done on so many occasions during the QE period. We take solace in the Fed’s words and buy stocks out of it.


Per Bespoke from the Sept 17, 2014:

Since December 2008, when the Fed’s near-zero interest rate policy began, the S&P 500 has averaged a 0.5% gain on days when the Fed has released its policy statement, according to Bespoke. The S&P 500 has risen during the past three Fed days and five of the past eight.