Notes From Underground

Yes, the day of decision is upon us and everybody is SURE of a 25 basis hike from the FOMC. IF I WAS IN CHARGE–NO, NOT JOSE CANSECO, WHICH WOULD BE MONETARY POLICY ON STEROIDS–I WOULD RAISE RATES 50 BASIS POINTS AND ISSUE A WARNING OF MORE AGGRESSIVE INCREASES TO COME. Alas, I am but ashes and dust. The FED has prepared the market for a certain 25 but here are the things to watch:

1. How does the vote go? Is it 9-1 with, Lael Brainard opting for no increase because of the recent strength of the U.S. dollar, a formidable headwind for the U.S. economy, and, more importantly, the potential negative impact on emerging market economies? The rise in rates combined with a strong dollar will cause pain for emerging market corporations who have borrowed heavily in dollars. More importantly, watch to see how many of the FED governors vote with the regional presidents. But a 6-3 vote with the dissenters opposed to a rate rise would be very DOVISH and stoke a rally in myriad asset classes.

2. The FOMC statement will be followed by a Yellen press conference in which the tone will be established by the FOMC‘s INFLATION EXPECTATIONS. The employment data is now NONSENSE because by the FED‘s metrics we are at FULL EMPLOYMENT. The fact that we are at full employment is the reason the FED should hike by 50 basis points. The FED‘s policy has caused an excess in equity and bond speculation, which has led to asset prices trading at market manipulated levels. It’s time to throw some COAL into the fantasies of Wall Street sugar-plum fairies. Either the stock market is right about exuberant GDP growth in 2017 or the FED is correct about lower for longer.

THEY BOTH CAN’T be correct. If higher growth begat higher interest rates and sustained wage increases then the equity markets are rising into unsustainable territory. Yes, Bernanke’s Portfolio Balance Channel has been in force for six years since the August 2010 Jackson Hole speech. Equity markets are the proud parents of TINA (there is no alternative). But TINA is rational only at certain valuations. So, what do we look for?

3. So if the FED ONLY raises 25 basis points as expected and the forward guidance is DOVISH, I would expect the currencies to rally after the initial break, as should GOLD after its initial break. The ALGOS will react to the HEADLINE OF THE FED RAISING RATES, but I advise that you should have key support areas in place that should hold. The ultimate KEY for the day, in my mind, will be the performance of the YIELD CURVES for if the FED is deemed to be DOVISH, the 2/10 and 5/30 should resume their recent steepenings. If the FOMC statement and the press conference are deemed hawkish the curves OUGHT TO FLATTEN. Be patient and let this indicator evolve, especially because of the Yellen press conference. The yield curves should be a Thursday play because of the ECB’s potential to distort the U.S Treasury market with its QE program.

THIS IS VERY IMPORTANT AS THE ECB HAS 55 billion euros of assets to PURCHASE and this is a short month since they pledged to be finished by December 22. Watch French and German sovereign debt as they have not rallied much. It APPEARS the ECB purchases have been weighted towards Italy and Spain, but that is conjecture on my part based on the price action since the Italian referendum. The U.S. 5/30 and 2/10 curves are virtually unchanged on the year, even as the U.S. is at full employment and the SPOOS are higher by 10 percent. The increased ECB, BOJ and even BOE purchases have accomplished the compression of global bond yields.

4. If Janet was to be the anti-Claus and deliver a 50 basis point increase in the FUNDS, let the markets clear and see what evolves during the following 24 hours. The huge amount of COMPLACENT risk-on going into year-end would prompt position readjustment. Holiday markets are too thin for “trading highways jammed with broken heroes on a last chance PROFIT DRIVE, will leave you with no place left to hide.” Be vigilant and don’t take unwarranted risks. It is not in Janet’s disposition to take aggressive action and the market has certainly supported that view, but this is the year of Brexit, The Chicago Cubs and Donald Trump’s election. Conventional wisdom is oh so conventional, especially in the era of central bank hubris.

Tags: BOE, BOJ, Dovish, ECB, Fed, hawkish, Janet Yellen, no way Jose (Canseco), QE, rate hike, U.S. Dollar, yield curves

This entry was posted on December 13, 2016 at 8:18 pm and is filed under Currency, Debt Market, Fed. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.