Since December, stocks have been mired in a long, churning, sideways trading pattern as the QE3 bond buying stimulus ended and everyone waited with bated breath for the inevitable: The first hike in interest rates from the Federal Reserve since 2006.
It could come as soon as soon as Wednesday’s FOMC meeting.
A June interest-rate hike is still seen as very remote possibility despite evidence of a second-quarter bounce back in the economy, steady job growth and evidence that inflation has stabilized. But there still is some nervousness about soft industrial production, an uncertain outcome of Greek bailout negotiations, and the ongoing drag of the stronger dollar.
For that reason, a September rate liftoff is seen as the most likely scenario at this point. Yet every little detail of new information from the Fed will be parsed for clues as to whether this is true and what comes after.
Here are four things to keep an eye on during Wednesday’s FOMC meeting.
Hike or No Hike?
Click to Enlarge Obviously, the single most important factor will be whether Federal Reserve chairman Janet Yellen lifts policy rates up from 0% — where they’ve been since 2008. Wall Street analysts are talking up the risk of a surprise hike since the Federal Reserve has delivered surprises before, including former Fed chairman Ben Bernanke’s “taper tantrum” shock of early 2013.
As noted by economists at IHS Global Insight, this will be the first FOMC meeting in nine years in which the members will actively consider lifting interest rates.
Thomas Costerg at Standard Chartered believes the Fed’s internal debate will hinge on two issues. The first is whether economic weakness suffered in the first quarter — including private consumption — which would signal underlying fragility that has been underestimated. The second issue is whether the U.S. economy’s medium-term growth prospects have been lowered.
The debate of this outcome will determine whether a surprise is delivered.
The “Dot Plot”
Click to Enlarge The next most important development will be whether there is movement in the interest rate forecasts of individual Fed policymakers in the Summary of Economic Projections.
The SEP, or “dot plot,” delivered a bullish surprise to stocks when last released in March after it revealed a less hawkish estimate of where interest rates would end the year — bringing the Fed’s own estimates closer to where the more dovish futures market is.
Michael Hanson at Bank of America Merrill Lynch told clients in a research note Friday that the updated “dot plot” of Fed interest rates expectations should still pencil in two rate hikes this year and four in 2016 — suggesting rate moves in September and again in December.
GDP Growth Revisions?
Click to Enlarge After the dot plot, Wall Street will be watching how the Fed decodes the mixed economic data we’ve seen so far this year when they update their full-year GDP growth forecast.
Societe Generale’s Aneta Markowska putting the odds of a June rate hike at “virtually zero” driven by a likely downward revision to the Fed’s full-year 2015 GDP growth estimate to a range of 2% to 2.2% from 2.3% to 2.7% at the March meeting.
Markowska expects Fed chairman Janet Yellen to express cautious optimism on the labor market in her post-announcement press conference, but also frustration at an ongoing lack of wage inflation and the unevenness of economic growth.
Market Response to the FOMC Meeting
Click to Enlarge The potential remains for a negative market response as traders have grown scarily dependent on the promise of cheap money from the Fed to sustain a bull market that hasn’t suffered a normal 10%-plus downside correction since early 2012. Even after the adjustment in March, the Fed’s dot plot reflects a much more aggressive path of interest rates than futures traders are pricing.
That suggests the assumption that the Fed’s cheap-money stimulus will go on forever is misplaced, setting the stage for disappointment after Wednesday’s FOMC meeting.
Bottom Line
I can’t say I blame folks for believing the Fed is too hawkish and optimistic in its expectations. The futures market has been fooled over and over again during this recovery on the likelihood of Fed rate liftoff, as shown above.
In each of the last seven years, higher interest rates appeared to be just over the horizon. And each time, some new problem appeared that stalled economic progress, spooked markets, and undermined job gains.
Will we actually get a hike in interest rates from this FOMC meeting?
With the unemployment rate at 5.5%, job openings at record highs, and inflation stabilizing, it looks like it just might — perhaps as soon as Wednesday.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two- and four-week free trial offer has been extended to InvestorPlace readers. Clink the links above to sign up.
