Notes From Underground: Things To Do Before Thursday’s FOMC Decision

As we head into decision day on U.S. interest rates it is important to note that all the major equity indices remain under their 200-day moving averages, despite recent rallies amid short covering (and bargain hunting remains an active sport). The consensus based on the pricing of FED FUNDS futures contract has the odds in favor of a NO CHANGE in policy by the FOMC. I caution that bargain hunters have been on the prowl as the voices of Summers, Lagarde, World Bank and others have given fortitude to those needing to put cash to work. If the FOMC stays the present course the immediate impact MAY be an initial equity rally but be patient to see how the market is reacting after at least 12 hours.

Some investors may be concerned that the FED sees trouble on the horizon and is adverse to raising rates as they don’t want to be held responsible for igniting a new firestorm in financial assets. This conundrum is the result of the FED‘s POOR communication program as well as the response to the TAPER TANTRUM of May-June 2013. It is the FED‘s fear of a market reaction function that leads to a large selloff in financial assets in the face of low inflation that creates all of the uncertainty. The FED may say it’s DATA DEPENDENT but it fears the reaper wielding a scythe to the overgrown valuations of the global equity markets. The following are the 200-day moving averages for global equity markets (numbers may vary depending on what chart system you use but should be close enough for hand grenades):

SPOOS: 2065
Nikkei: 19160
Dax: 11,025
Footsie: 6684
CAC: 4807
Shanghai: 3718

The weakness in the equity markets may provide the data-dependent FED reason to keep rates steady as it stresses the need to watch international developments. The inverse side of the stock market action is that the DOLLAR is losing strength against some currencies as the YEN, EURO and BRITISH POUND are hovering around their 200-days so fear of a strong dollar is not as great as at July’s meeting. Is the recent weakness portending a fear of a weakening U.S. economy or is it merely the unwinding of long hold bullish U.S. dollar positions as anxiety builds over the global financial system?

***Last night the BOJ kept its interest rate and quantitative easing program unchanged. This was expected by NOTES FROM UNDERGROUND as I have written that the Japanese will remain cautious about adding more stimulus while the world is trying to sort through the recent devaluation of the YUAN by Chinese authorities. Everything is status quo for central banks until the FED makes a decision and more is heard about the condition of the Chinese economy. Also, don’t forget that there are elections in Greece this Sunday that can also impact markets by a surprise vote that undermines the power of Alexis Tsipras. Credit markets have grown complacent about the Greeks adhering to the agreement reached with Brussels.

***A juxtaposition of thought. In the September 8 Financial Times, there was an article titled, “The Printing Press Rolls … But Spending Lags.” The paper was questioning the ECB‘s present policy of QE for its failure to ignite capital expenditure. The same problem has plagued corporate America and of course undermined the FED‘s models on predicting the outcome of the effectiveness of the three QEs. In the U.S., many corporations have used the ultra-low interest rates to take on debt in order to financially engineer P/E ratios by buying in massive amounts of equity. In Europe, some companies have used to cheap debt to enhance stock performance but not anything close to what has taken place in the U.S. The article quotes Stefan Schoeniger of KPMG Hamburg: “Companies are not substituting debt for equity or using cheap debt to fund  capex and investments at the moment….”

Further it is noted–and I believe this is important for investors to absorb:

“Wolfgang Buechle, CEO of Linde, the German industrial gas and plant engineering company explains why: ‘Cheap money is easily available and quite a few of the investors asked quite straightforwardly: why don’t you releverage the company and pay an extra dividend?’ But I said very clearly no, because if tomorrow the economy is shaken up you are the first ones to claim: ‘why did you do that?’ We are obliged to run a stable balance sheet …. rather than embarking on opportunistic possibilities that might not be beneficial in the long run.”

This is definitely not the mindset of Wall Street and American corporate CEOs. Keep this in mind when stocks present good value those balance sheets with less debt will prevail, especially when the DEBT has been used for financial engineering and to sustain dividends in the face of slowing profits.

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12 Responses to “Notes From Underground: Things To Do Before Thursday’s FOMC Decision”

  1. Chicken Says:

    Sounds bearish.

  2. the american limey Says:

    into the valley of easing rode the 650 million, debt to the right of them, economists to the left…

  3. arthur Says:

    Don’t fight the Fed.

  4. AZRondo Says:

    Oh boy! So since I wasn’t highly levered (as a family) before 2007, and have refused to become so, believing that QE (shorthand for ALL of the shenanigans by central bankers/central planners), I might end up OK.

  5. yra Says:

    AZ- I am in hte same camp as you—although Trump would differ and look where it has gotten him–leverage is great as long as asset prices are going your way—tough when it turns –watch the play out of the risk parity trade

  6. Asherz Says:

    Don’t fight the Fed. Good advice Arthur much of the time. Except when they created the dot com bubble and had NASDAQ decline 80%. Or when they caused the housing bubble followed by the financial meltdown. You now have the largest bubble in bond and stock market history with the tail of the stock market wagging the head of the Central Bankers from Washington to Brussels to Beijing. The quiver has very few arrows left. Q4 anyone?
    We aren’t arresting traders and journalists yet as they’ve done abroad, but all hands are on deck to prevent the crash.
    Ultimately the last word will come from the economy which always (surprise) determines market levels.

  7. Dan DeRose Jr Says:

    Yra, Great post as always! Wolfgang Buechle sure isn’t an American capitalist. Maybe his PhD in chemistry (an actual physical science) is impeding his ability to understand what economists today (pretend physical scientists) are trying to accomplish! Keep up the great work and beware technical levels in the short end too! 80bp in the 2yr anyone?

  8. Rob Syp Says:

    good fortune to everyone tomorrow

  9. yra Says:

    aherz;well stated and point on as the call of don’t fight the Fed is hard to measure in a ZIRP negative real yield environment–to the barricades and monitor the yield curves as the markets attempt to measure the FED’s raise of 25 basis points tomorrow

  10. yra Says:

    Dan DeRose –are you implying that for some it may actually be rocket science.

  11. Chicken Says:

    No rate increase despite global recession.

  12. A.M. Look 9/16/17 | Says:

    […] Yra wrote a great piece last night on the impending FOMC decision. […]

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