The Fed Makes a Difference
Although Ms. Yellen reemphasized that the Federal Reserve is not on a preset course with its monetary policy, the Fed is non-the-less biased toward tightening. This, despite the fact that tax legislation (or any legislation, for that matter) has yet to be passed. It means that the Fed has confidence in the U.S. economy and in its ability to invite higher inflation.
Here is the summary of major conclusions from the Federal Reserve statement:
The following chart shows the CME Fedwatch target rate probabilities for December 13 as per our update earlier in the week.
And here is what happened after the Fed’s comments.
The market now understands that the bias in rates is up. Adding to this bias, is the balance sheet reduction which starts next month. As we pointed out in our update, since the Fed will not be reinvesting the entirety of the interest and principle from maturing bonds, demand for bonds will be lower, and that should put upward pressure on rates.
We think it is important to provide a historical as well as comparative view of the Federal Reserves’ balance sheet to have proper perspective. The chart below shows how the fed’s balance sheet grew to 23% of GDP as a result of the great depression, and then took fifty-years (1984) to return to pre-depression levels of about 5% of GDP. The chart only includes 2012, but today the balance sheet is around 22% and we can expect that the reduction is going to be slow once again, with a target of 13% of GDP by 2021 — assuming a recession doesn’t hit in the interim.
The chart below compares the balance sheet levels of the other major central banks. The ‘fat boy’ in the class is obviously the Bank of Japan with nearly 50% of GDP. The European CB has been reducing its balance sheet for some time, which may explain why its equities markets have not appreciated as much as the ones in the U.S.. {This section is for paid subscribers only}
Reducing the balance sheet is reverse QE which is likely to affect equities in the coming months, even if it is only a slowdown in the pace of new stock market highs.
Equities
This bull market is relentless! We think we are in a long-term, late-stage bull market that is likely to continue for another 12 to 18 months, but we also have been expecting a correction in this bull. The latter, has yet to materialize.
Longer-Term
Based on sentiment, the level of fear continues too elevated for the creation of a major market top (chart below).
Fundamentally, GAAP earnings continue to grow (chart below).
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Technically, the long-term moving averages continue in bull market formation (chart below).
Shorter-Term
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The put-to-call ratio has spiked down which implies a 12/15 chance of a local top forming (chart below).
Oil
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Gold
Having failed to make a higher-high, gold finished the week at the lower boundary of support and the momentum indicators are negative (chart below).
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The TIPS bond etf (TIP) is a proxy for inflation expectations. Although it is elevated, recently it has dropped back to correlate with the move in gold (chart below).
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ANG Traders
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Source: Nicholas Gomez