We are now just hours away from the most important Federal Reserve policy decision in a generation — one that could result in the first interest rate hike in nine years, putting an end to the greatest experiment in cheap money policy in human history.
Yet, stocks moved higher again on Wednesday, as the market leans toward the Fed once again giving the market what it wants and waiting, possibly until 2016, before endings its near-0% interest rate policy that’s been in place since 2006. Futures market odds put a rate hike now at less than 30%.
“No hike” hopes have been bolstered by a batch of disappointing economic data this week on retail sales, industrial production and consumer price inflation. That has lifted equities, bounced precious metals and pushed up bond market inflation expectations in a way not seen since April.
In the end, the Dow Jones Industrial Average gained 0.8%, the S&P 500 Index gained 0.9%, the Nasdaq Composite gained 0.6% and the Russell 2000 gained 0.8%.
Commodities were big winners, with gold adding 1.5%, crude oil adding 5.9% to close at $47.21 a barrel and copper adding 1.1%. That boosted the collection of gold mining stocks recommended to Edge subscribers by 6.9%, including a 10.3% gain in Kinross Gold (NYSE:KGC) and a 7.2% gain in Barrick Gold Corp. (NYSE:ABX)
Oil was also helped by an EIA inventory report showing stockpiles declined by 2.1 million barrels last week vs. expectations for a 1.1 million barrel build.
No surprise then that energy stocks were the day’s best performers rising 2.8% as a group, including a 2% gain for Exxon Mobil (NYSE:XOM) — which was one of a group of energy stocks I flagged as preparing for a big move earlier this week.
In corporate news, FedEx (NYSE:FDX) dropped 2.8% after announcing weak earnings and raising shipping fees while Fitbit (NYSE:FIT) gained another 12.3% thanks to announcement that Target (NYSE:TGT) would offer activity trackers to 335,000 employees.
Concerning Thursday’s big Fed decision, investors were encouraged by a weaker-than-expected CPI report that shows price pressures have eased off again thanks to recent softness in energy costs. The headline CPI turned negative for the first time since January. Following weak retail sales and industrial production data on Tuesday, it looks like the Fed will have plenty of justification for a “no hike” decision.
And yet there is a nagging fear the Fed could shock everyone by delivering a hawkish surprise given cumulative progress on job gains and economic growth.
A survey of 135 institutional investors by Alberto Gallo at RBS revealed the depth of the cognitive dissonance in play.
A majority believes the Fed should hike rates now, as 63% believe central bankers are losing credibility with their repeated kowtowing to markets. Gallo adds that it’s becoming increasingly clear that extreme monetary policy is clearly becoming less effective the longer it goes on; while (worryingly) making an eventual exit increasingly difficult. Eighty percent of those surveyed believe the Fed should hike by the end of the year.
It’s hard to feel sympathetic as the Fed’s easy money juicing of stock and bond prices were justified by the positive “wealth effect” that resulted. In 2010, after unleashing the $600 billion “QE2” bond purchase program, former Fed chairman Ben Bernanke wrote in the Washington Post that the action was done in part to lift stock prices to “boost consumer wealth and help increase confidence, which can also spur spending.”
Remember, all of this is the result of efforts to end the financial crisis that resulted from the bursting of the housing bubble and the mortgage-backed securities that funded it — a speculative fever caused by the Fed keeping interest rates too low during the mid-2000s.
Yet, according to Gallo, only 42% of respondents believe the Fed will hike now. The International Monetary Fund, Chinese policymakers, Goldman Sachs and Larry Summers are among those warning the Fed that a hike now would be premature. Central banks that have attempted to raise interest rates since the financial crisis, such as those in Israel and Chile, have all had to subsequently backtrack and cut rates to various degrees.
Gallo outlines the price of kicking the can: “More than the risks to financial markets and asset prices (from a sooner-than-expected rate hike), investors are concerned with structural imbalances building up further if ultra-loose monetary policy continues.”
Yet the most likely response, as revealed in the survey data, in futures pricing, and in market action this week, is another policy punt. Morgan Stanley’s Guneet Dhingra notes that in the 1999 and 2004 rate hike cycles, the Fed only moved when the market was fully prepared. In the 2004 campaign, no hikes occurred unless futures odds were 79% or higher the day before the decision.
Our central bank simply isn’t in the business of delivering hawkish surprises to the stock market anymore. And institutional investors know this. Yet this only raises the stakes for the next “will they or won’t they” rate decision in October.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
