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Thoughts on FOMC Day

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Posted by Gary Tanashian via NFTRH

on Wednesday, 26 July 2017 08:20

It is FOMC day, a periodic ritual where a group of economists get together and pretend to have decisions to make about interest rate policy. Well, according to CME and the Fed Funds Futures there is a 97% chance that the Fed sits on its hands today. That won't be a surprise.

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But Janet Yellen has a little problem and his name is Uncle Buck. The US dollar index and its pairing vs. several global currencies are on the verge of collapsing below important support levels. This update on currencies from this week's NFTRH 457 explains why I am short the euro and prepared for the USD to find support and bounce. Now, at this point that is just a contrarian's fantasy because the market says USD is in trouble. But have a look at the post and see if you might agree with some of its premises, especially where sentiment and Commitments of Traders are concerned.

So here we have the Fed, overseeing a massive bull market in stocks and ostensibly in accommodation removal mode. My premise since the election of Donald Trump has been that the Fed could now slowly and routinely remove the monetary policy stimulants it had injected into markets nearly non-stop during the Obama years because that admin's goals depended on monetary policy (i.e. monetary stimulation, because there sure was precious little real economic stimulation going on) whereas the new Republican policies would depend upon fiscal stimulation. I would argue, however, that "fiscal stimulation" may be code for 'dollar devaluation' to spur exports and boost manufacturing.

So a big question now is whether the Fed, despite its slow tightening regime and stated intention to implement future rate hikes and reduce the size of its balance sheet (USD-supportive actions) actually means business, leaving the Trump admin to its fiscal policies; or whether the Fed will 'play ball' with this admin in a different way.

Core to the Trump fiscal agenda would be a weak US dollar. We just may get a look at Yellen's cards today. If FOMC rolls over and keeps things well and dovish despite the weak USD, we'd have a clue that they are on board the weak dollar express. But what if the Fed chooses to support the dollar through some subtle jawboning about future hikes and balance sheet reductions? I have no real dog in this fight. I'm just trying to make sure NFTRH is on the right side of it.

Looking at it from a different angle and taking out the political while only considering market-oriented inputs, here is a big picture look at previous Fed tightening cycles. The stock market topped on the last two occasions that the Fed Funds Rate (FFR) caught up to and slightly exceeded the 2 year Treasury yield. But a more acute signal was when the 2yr began to decline and negatively diverge the FFR (note the red lines on the chart below).

 

Looking at the chart one might say that the 2yr and FFR have a long way to go before they reach a topping area equivalent to the 2007 example; but one might also look at the S&P 500's mega hump and ask... 'Really? That was 7 years of Zero Interest Rate Policy!' The above is a picture of a distortion built on years of out-of-whack monetary policy (note how the 2yr began to rise in 2013 and the FFR did not start following it upward until late 2015). Maybe 1-2% is all that the Mega Hump and all that hot air can take on this cycle. It is the relationship between the 2yr and the FFR that will be important. At a current 1% to 1.25% the Fed is approaching the 2yr's 1.4% but the market appears fine for now (and a bull trend is a bull trend until it no longer is).

A central question going forward is whether or not the Fed will choose to support the dollar and head off inflation, or wait to see the white's of its eyes? Since the election the stock market has been very much tied to a dollar depreciation theme (and has, since 2011 been a primary beneficiary of the Fed's inflationary operations). The last big rise in USD preceded a significant corrective phase in the markets (2015 into 2016). So which cards will Yellen show with respect to Uncle Buck and his current precarious state?

Gary Tanashian

 

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“Great call picking the [gold stock] bottom last week Gary!”  –Frederick L  9.6.16

 
 
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