Markets had been drifting lower over the last few days in anticipation of a more hawkish outcome from the Federal Reserve’s latest two-day policy meeting, due to wrap up on Wednesday.
Given the robust performance of the economy over the summer, investors are preparing for the Fed to confirm this by ending the QE3 bond-buying program in October and moving forward the timing of its first short-term interest rates hike since 2006 into the middle of 2015. This was a change from the September 2015 timing that Wall Street analysts had penciled in.
Click to Enlarge So the dialogue was all about the end of the steady flow of cheap-money stimulus.
That changed on Tuesday, sending the Dow Jones Industrial Average to record intraday highs (although the S&P 500 couldn’t close above the 2,000 level once again). Here’s why.
It started when the Wall Street Journal’s Jon Hilsenrath — the Fed’s preferred media leak outlet — said the removal of the “considerable time” language from the Fed’s statement wasn’t a sure thing. These two words concern the timing of the first short-term rate hike after QE3 ends in October. It’s seen as representing about six to nine months.
Since the phrase is attached to language about the QE3 program, it will be dropped at the October meeting since that’s when QE3 is scheduled to end anyway. That makes it a neater way to drop the language without spooking investors. Especially since the Fed is likely to elaborate on its exit strategies, that is, the tools it will use to manage interest rates higher at a time when it has expanded the monetary base to more than $4 trillion from $800 billion before the recession.
In Hilsenrath’s words, both a change in rate guidance and the elaboration on exit strategy might be too much for investors to handle.
Also helping was the announcement of new stimulus measures out of China (a liquidity facility for the largest banks) and word that Japan will downgrade its economic forecasts this month (a possible prelude to additional stimulus measures).
The end result was a near-vertical ramp in stocks and risk assets in general including commodities, currency carry trades, bonds, and precious metals.
As a result, expectations are high that the Fed will deliver on what Hilsenrath teased. That’ll be tough given the plethora of Fed datapoints that are about to be released including the post-meeting statement, the summary of economic projections (known as the “dot plot”), and chairman Janet Yellen’s press conference.
So it’s not surprising that some apprehension crept back into the market heading into the closing bell. Stocks finished off their best levels. Treasury bonds finished deep in the red after flirting with gains mid-day. Junk bonds pulled back for a small 0.1% gain on the day. Precious metals gave back the majority of their gains. And the U.S. dollar, which dipped on the Fed news, rebounded.
Click to Enlarge Clearly, tensions are high and the stakes are even higher as the market, after skidding sideways over the last few weeks, looks ready for a decisive break up or down out of its recent trading range. I continue to recommend positions that should profit from the long-term truth that the Fed’s tightening cycle — despite month-to-month tweaks on timing — is coming.