Days before the FOMC's meetings, the spotlight shifts to focus on monetary policy. Traders on the floor and the internet find ways to tune into the world's largest central bank's mind. Where once the Maestro led with few words, now come parched attempts of explaining the Fed's economic plan. In charge of the U.S. monetary positions, Janet Yellen must extricate the country from the particularly sticky situation offered by the world's recent slowdown. A correction in August ruled out interest rate hikes for the rest of the year. All the while, the Fed's Chairwoman must find routes to unwinding her central bank's expansive asset positions instituted on the balance sheet during the 2008 Financial Crisis, a traumatic period during which she served as a Fed Board member. Tons of issues clutter the meeting's atmosphere, towered by the global economic slowdown which continues to echo in statistics coming out almost every day. During this trading session, both the indicators on U.S. durable good production and consumer confidence came in lower than expected. The index measuring consumer confidence actually saw a difference of over 5 points between the real (97.6) and consensus (102.8) statistic. That certainly doesn't support rate hikes this meeting and adds to the power behind the low probabilities traded on the Fed Funds future contract. After many governors have done all but guarantee near-zero rates, the meeting becomes refocused on sending the right message to markets, both domestic and foreign, which both reacted to the actions of the Chinese and European central banks. But communicating those positions is not always easy. To make use of a metaphor, imagine a yoga instructor walking her students through an exercise. In order to emphasize fluidity and core strength, she highlights the importance of slow, deliberate movements to shift from pose to pose. Janet Yellen must be the markets' yoga instructor, but her comments and concerns must be thought-out, gradual, and deliberate. Choppiness in both yoga and macroeconomics is very unhealthy and increases the risk of volatility. With the use of very soft, but hopefully very direct, language, the markets must be massaged back into a position where growth is normal, and rate hikes are sensible, much like an athlete stretching to reach optimum athletic performance. Fed meetings are also important because they can make a huge impact on the stock market for just happening, and sometimes that effect can be exacerbated by what people think will happen.
The market has a useful way of letting the market bet on the future of the Fed Funds rate, a monetary tool that used to be hidden behind a veil of uncertainty. Now, traders can buy and sell contracts based on how they think the Fed will rule each month, providing a method for the Federal Reserve to check how they well they communicated their desired position. The chart above plots the projected interest rate in the next year. According to the futures contracts, investors do not see rate hikes as anywhere near likely until the middle of 2016. In fact, through March 2016, the Fed Funds future contract predicts interest rates to stay below the upper bound of the currently bounded policy instituted by Bernanke's Fed during the recession. Interest rate movement is not expected to see increased consideration until April of 2016. My chart reflects an initial increase of 25 basis points at the first round of tightening, and thus, see interest rate projections below 37.5 basis points as still being assigned a small probability. With this in mind, investors predict that rate hike probability won't be over 50% until August of 2016, a year after the correction that changed the Fed's course of action. What does this tell us? As of now, this is the "monetary narrative" that investors see the Fed following. Janet Yellen will look at these numbers and decide whether they describe the Fed's actual plan because if they do not, she will have to use careful language to adjust them appropriately. Providing plenty of warning without an outright explanation of what is to come encompasses the crux of a central banker's job in market communication. With the use of tools like inflation targetting and various charts and data produced by the FOMC, comments and announcements can affect long-term interest rates assigned to Treasury bills as well as risk spreads on corporate debt. With errant or convoluted remarks comes the chance that further volatility can plague the bond market making firms and their investors unsure of how to value debt. This will become very important as energy companies struggle with cash flow problems, and corporate earnings drop overall. As we wait in the lull between Fed announcements and the beginning of the week, expect another day of limited movement with the direction of major indexes being determined by recent earnings and the performance of oil. But for investors looking to the future of stocks, many predict a dimmer outcome as tightening becomes increasingly likely. Futures contracts for the Dow and the S&P 500 show a major drop-off of about 1-2% of each index, reflecting the belief that a bearish move might be due with a higher Fed Funds rate. Touching on the yoga metaphor once more, the stretching and limbering of systems that have been slow will bring on much soreness after intense action is reintroduced. For the U.S. economy, a bull rally will not just fall on our feet, instead, healthy GDP growth and respectable inflation will only show themselves with value to escort them.
Please excuse my delving into monetary policy. I realize that my focus is on oil and energy for this blog, but my forays into other topics can't help but spill over into my writing. So please, enjoy my deviations and enjoy an eclectic approach with me.
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