Aug. 27, 2016, Weekly Summary: The FED Effect

As we stated last week…”  This bubble has been created and sustained by the FED’s actions, and it will be the FED’s actions that kill it.”  As such, it is no surprise that Janet Yellen’s much anticipated speech would have an effect on the market; Janet spoke, and the market took off.

Here is the crucial statement from her speech (emphasis is ours):

“…in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months. Of course, our decisions always depend on the degree to which incoming data continues to confirm the Committee’s outlook.”

Now, you would think that such a pronouncement would scare a market that is built on low interest rates, but no, the market rallied, demonstrating complacency and the assumption that the FED chairwoman was bluffing (again).  Since she did not explicitly say that a hike was in order for September, her statement was dismissed as meaningless chatter.  The markets rallied all morning until Fed Vice Chair Stanley Fischer appeared on CNBC.

CNBC asked Mr. Fischer if markets should be on the edge of their seats looking for a rate hike in September and more than one rate hike before the end of the year.  After a long ramble, it came out that the answer to both questions is ‘yes’, but with the caveat that the Fed still needs to see what the incoming data will look like.  The market turned on its heel and headed south for the rest of the day, and according to the CME FedWatch Tool, the probability of a September rate hike moved from 21% up to 33%, and the chance of a December hike went from 52% to 60%.  Fischer produced a flash of fear in the market.

The labor data that has been produced during the last two months shows healthy growth, and if it continues, it will give the FED the excuse it is looking for to start normalizing interest rates.  However, we don’t see a rate hike until after the election unless there are some surprisingly strong economic numbers in the next two months.  December, however, would be very much in play if growth continues at the present moderate pace.

The graph below (from Yellen’s speech) shows the wide range of rate possibilities for the future.  The only half-useful information in the FED’s chart is the rising average blue line which shows an upward bias to rates.

Interestingly, at the end of her speech Yellen referred to the usefulness of fiscal policy (which the FED has no control over) in helping the economy recover:

“Though outside the narrow field of monetary policy, many possibilities in this arena are worth considering, including improving our educational system and investing more in worker training; promoting capital investment and research spending, both private and public; and looking for ways to reduce regulatory burdens while protecting important economic, financial, and social goals.”

That statement is reassuring since we have always maintained that the FED has been fighting with the fiscal arm tied behind its back.  The time to invest in infrastructure is now while money is almost free and wouldn’t have to be paid back for fifty years (which is close to never).

The Market

Let’s have a look at the patterns that we are following.

The chart below shows how the ‘low bull sentiment at market tops’ pattern is still in play with this week’s bull sentiment dropping down below 30% and the SPX  starting to roll-over.

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The counter-trend sentiment pattern that occurs prior to a correction is still in play and indicating a down market (chart below).

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Gold

In the past, we have pointed out how gold is negatively correlated to the dollar and interest rates, and positively correlated to inflation.

The chart below shows the inverse relationship between gold and the dollar.

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The commitment of traders continues at historically high levels.  As always, the commitment information is only inclusive of Tuesday.

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We wish our subscribers a profitable week ahead.

Regards,

ANG Traders