ALL BUT IMPOSSIBLE
2016-09-06 4pm EDT | #Dennis Gartman #Fed #FOMC #
Most market participants are now convinced the Federal Reserve will leave rates unchanged at the coming September meeting. Some have even gone as far to call a September hike “impossible.”
Making fun of Gartman doesn’t even seems sporting anymore. We all know he is already living on borrowed time (Our Favourite Whale Oil Trader), so why does he keep begging for a bruising?
September Fed hike “all but impossible?” Improbable, yes, but, impossible? No way.
Although Dennis is by no means alone in his belief the Federal Reserve is on hold until after the election, it is nowhere the “sure thing” that many are trumpeting.
I know, I know… The Fed has promised many rate hikes over the past year and a half, only to back out at the last minute. It has become so common place that most Wall Street strategists have a picture of Lucy pulling the football away on Charlie Brown tattooed on their backs.
Last Friday’s tepid employment report and yesterday’s downright poor ISM release certainly emboldened traders to reduce the chances for a September hike. The ISM report in particular caused bonds to scream higher, the US dollar to sell off, and for gold and silver to run like they stole something.
It’s as if traders came back from the Labour Day long weekend and decided their previous interpretation of a reasonable chance of a September hike was nothing more than a “too many cocktails on the beach” summer pipe dream.
And I think I know the reason for this violent market reaction. During the last week of August, a handful of influential market strategists, including Goldman Sachs’ economist Jan Hatzius, advised of a better than 50⁄50 chance the Federal Reserve would hike in September. Even after the mediocre employment report, Goldman Sachs was still pounding the drum on a September hike:
“It was a little below expectations, but for us, it’s just enough to make it a little more likely than not that they do go in September,” Hatzius told CNBC.
In illiquid late August trading, the front end of the curve backed up as market participants worried about these hawkish forecasts.
Yet yesterday’s poor economic releases caused a reevaluation. Combined with doubts the Fed would hike in front of the election, investors have suddenly decided it is as Gartman described, “all but impossible” for the Fed to hike in September. That is why yesterday investors aggressively sold US dollars, and bought precious metals and bonds.
But in their haste are traders creating an opportunity?
I understand the reasons traders believe the Fed will not raise rates in September. Their reasoning makes tons of sense, and more importantly, the Federal Reserve has long since lost the last shreds of credibility they were clinging to. The Fed have become the little boy who cried wolf too many times.
I do not believe the Federal Reserve should raise rates, but that doesn’t really matter. We shouldn’t care about what should be done, but instead focus on what will be done.
Herein lies the problem the Fed has created for itself. After all their false starts, confusing opposing guidance from different FOMC members and overall bungling of their communication, market participants no longer believe Federal Reserve officials.
I have long argued the Federal Reserve’s excessive communication does more harm than good. The myriad of different Fed voices filling the airwaves only serves to confuse markets. But more importantly, the Fed does not realize guidance towards tighter monetary policy often makes an actual adjustment unnecessary. Past attempts to prepare markets for a higher Fed Funds rate caused the US dollar to rally, scared markets and caused business confidence to immediately sag. By the time the Fed got around to following through on their promised hike, the economy (and markets) were in such disarray, they were forced to pull back on their guidance.
Michael Gayed from Pension Partners recently penned a piece with a great title that I wish I was smart enough to come up with - Dear Fed, Please STFU. I couldn’t agree more.
Yet Janet & Co. are now facing an interesting dilemma. There is no doubt they want to raise rates.
Have a look at the synopsis of the last Federal Reserve meeting minutes:
DISCOUNT AND ADVANCE RATES – Requests by four Reserve Banks to maintain the existing rate and requests by eight Reserve Banks to increase the primary credit rate.
Twice as many Reserve Banks recommended raising rates. But what did the board do?
Existing rate maintained. - July 25, 2016.
According to the base Taylor rule, Fed Funds are now at the largest discount to the model as anytime during the past 30 years!
Although I am sympathetic to the argument the US economy is ill prepared to deal with a rate hike, most Federal Reserve officials are still playing by the old playbook. They believe that “zero was an emergency rate, and the emergency is long past.” This crew has tried to raise rates for the past year, but a too strong US dollar has kept them on the sidelines.
But look at the US dollar now:
The US dollar has stopped its dizzying ascent. When compared to levels from six months ago, it is now down.
When the Fed hawkishly attempted to tighten last winter, I railed that the global economy could not take the strong US dollar.
Yet for the past six months the US dollar has gone nowhere.
I have no way of verifying this, but one of the traders I follow on Twitter posted this interesting anecdote:
Although it is by no means this simple, this backs up my thinking about the importance of the US dollar in the Fed’s thinking.
And how about other financial markets?
The Fed induced mini-melt down last winter caused bond spreads to explode higher. But again, over the last six months, they have settled down.
Step back and think about the current economic and financial conditions from the Fed’s perspective. Is economic growth as much as they would like? No way. Is inflation hitting their target? Again, not really, but it is getting closer. But is the economy in a state that necessitates near zero rates? Not a chance.
They would have loved to tighten last year, but global markets did not allow it. But here we are, six months later, and although the economy is slightly softer, the rest of the world is in much better shape.
The US stock market is pushing to new highs. The US dollar has stopped rising. Employment is still at record tight levels. Financial conditions are extremely accommodative.
It’s not ideal, but the Fed will tighten. And they will most likely do it sooner rather than later.
Too many of their models are screaming for higher rates. They might not want to give up control of monetary policy to the Taylor rule, but they will only deviate so far before their bureaucratic CYA tendencies take over.
Although I don’t have anywhere near Dennis Gartman levels of audacity, I will stick my neck out to say the market is underestimating the possibility of a September raise.
Trading is all about finding opportunities where market pricing differs from actual probabilities. Of course it is impossible to know in advance the odds of an event happening (unless you are Dennis Gartman), but I believe this is a case where the market has misjudged the Fed’s intentions.
Many market pundits trot out the stat that the Federal Reserve has never raised rates if there was a less than 50% chance of a tightening built in. I believe there is a first time for everything… And maybe, just maybe, the Fed will follow through with their hawkish signaling of the past month regardless of what the market has priced. Nah, that can’t be… That’s all but impossible…