By the time you read this, the Fed Open Market Committee (FOMC) has probably raised their benchmark Fed Funds rate and given guidance for the next few years. More importantly, everyone has freaked out one way or the other and the stock and bond markets have probably done something that has everyone puzzled.
We still live in a financial world that defies expectations. It has to be “experienced”, just like the various things you did in your mis-spent youth that built “character”. The question becomes – what great wisdom are we learning from all of this?
Barataria has discussed perhaps far too much one particularly weird side effect that can be expected, which is based on the likely flow of money back home from developing nations. Low interest rates made loans in US Dollars look cheap for many years so the money went all around the world – as money does these days. When the FOMC plots a course for higher rates there is no good reason to be stuck with a loan in US dollars, meaning the money will likely become idle.
The upward pressure on US Treasuries is pretty much a given now. It’s been written about in the popular press and it shows up in a graph of rates on the 10yr bond, with the 50 day moving average (50 dma) shown in red:
While there’s a slight upward trend to rates it’s far from convincing. Interest rates are still subject to the gravitational pull of a lot of moolah looking for a safe haven, a process that should only accelerate after the FOMC announcement. Sell on the rumor, buy on the news – or something like that.
Other potential strange effects are being noted, too. The dollar has indeed strengthened on the likely rate hike, which shows up for most people as very cheap oil. That has tamed inflation and made a rate hike far less likely, or so goes conventional wisdom. But the Fed is not buying it. The key will be the plotted rate of increases up to a level that makes sense, probably in the 3% range or so by the Mankiw Rule. What everyone wants to do is start out slowly and see what shakes out.
In short, even the FOMC expects something weird to happen.
If the Dollar weakens, which has happened before in response to a rate increase, the price of oil might go up. Inflation might suddenly register. That could slow down the pace of rate increases over the next few years if it gets out of hand.
No matter what there is no fixed, sure answer at this point. The VIX, or implied volatility index, is starting to rise in response. It may hit 40 this week, which is to say a 63% chance of a rise or fall in the S&P500 of more than 40%. That means a fall of 40% to always-nervous traders who don’t like putting down their money when no one is sure of anything.
The bottom line for the FOMC is to start the process and promise a slow, gradual rise. Once everyone has a few weeks to digest whatever happens we’ll have news from holiday sales and a new jobs report to fret over. The sooner everyone stops worrying about the Fed the better.
It’s still a bad time to own stocks, however, given this much worry. The possibility of something really strange happening is starting to spook everyone.
Fasten your seatbelts and be glad you aren’t in China?