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Fed is Bluffing on Rate Hikes

Just over a year ago, I was still calling for new stock market highs to S&P 2250 based on two factors:

1. Earnings Growth of 10%+ ($125+ EPS on the S&P 500)

2. Fed Put Alive and Well

And my logic concerning the Fed in 2015 was that since market players knew they would go "low and slow" with rate hikes into the latter part of the year, that gave stocks a big, fat green light to rally.

You could liken this to 1999 when Alan Greenspan opened up the spigots ahead of Y2K.

But the market didn't take advantage of the "green light" conditions from the Fed in 2015 anything like they did in 1999.

Fast forward to today, and we have these two factors keeping the stock market aloft...

1. Earnings Recession Discounted (opposite picture from early 2015, and already priced-in as “over and done with”)

2. Fed Put Alive and Well

So the market could still pull off that feat of new highs right into economic and earnings weakness -- especially since the giant corporate “BuyBack Machine” can still vacuum up shares with eternally-cheap dollars.

 

How Long Will Fed Put Last?

Now, let's address that inflation-starved, dollar-hating committee we call the Fed, because their decisions could determine the fate of the stock market at this stage.

If they were really in rate "normalization" mode, we might feel better. It would mean the economy was humming, immune to problems in Asia and Europe, and that wages were rising.

But they are not in that mode. Even the hawks are backing off.

In the video that accompanies this article, I show you how to use the CME FedWatch tool to know what the market is forecasting for the next potential rate hikes.

The market has been right is maintaining very low inflation, and thus rate hike, expectations.

And not only has it been right, it has been consistent. In other words, while Fed speakers and FOMC meeting minutes in any given month could have us thinking about as many as 4 rate hikes or as few as zero this year, the market probabilities have never wavered from “1 hike or less.”

St. Louis Fed President James Bullard said in March that the market is wrong now and that inflation will run hotter into next year. But that is one economist's opinion against hundreds of billions of dollars worth of actual trading positions.

 

Fed Speakers Strongly Hawkish This Week

Richmond Fed President Jeff Lacker was not out of character at all on Tuesday April 12 expressing his views that the Fed should stick close to its December outlook of 4 rate hikes. Besides his hawkish reputation being maintained coming as no surprise to market players, they also thank their lucky stars that he's not currently a voting member on the FOMC.

Now here was a policy "centrist" who is also not a current voter. From Reuters

"I definitely see two or three rate hikes ... as being reasonable" this year, based on projections provided by Fed officials in March and the fact that economic data has not delivered any surprises since then, San Francisco Fed President John Williams told reporters after a speech here.

"In a way it doesn't matter so much whether we were to raise rates in April, or June, or...July," he added. "What matters is the path of interest rates and kind of the normalization process... As long as, I think, we stay on this kind of basic path of raising interest rates gradually over the next couple of years, that's kind of what's important for financial conditions."

What was also interesting about his comments was this...

When the Fed does raise rates, Williams said, "I don't really expect a lot of turmoil" in financial markets because the central bank will have telegraphed its intentions clearly.

On the surface this does not appear true.

The US dollar and the yield curve are in no way pricing-in anything more than 25 to 50 basis points in rate hikes this year and if so, it may not be until December.

So a June hike would indeed cause some turmoil.

Maybe the real take-away here is between the lines. The Fed is simply jawboning -- if not downright BLUFFING -- and getting the market ready for 2-3 hikes, so that 1-2 will once again seem ultra-tame.

Just like in December when I said "4 hikes created implied easing" because removing any one of them from the dot plot was almost like a rate cut.

This is still a masterful effort at managing expectations and establishing as much transparency into a very fluid and often messy "data-dependent" process as is possible.

Fed debate and dissent is good. As I've said many times, we want our top economists in heated debate about the possible future paths. It just seems almost too perfectly orchestrated to hear from so many hawks again after Chair Yellen nearly made them irrelevant a few weeks ago.

In reality, it is a little bit closer to "perfect chaos" as we know that many a Fed speaker is taking care of his or her own political agenda to be "the one" who spoke out against the doves.

To follow up this week's hawks, Atlanta Fed President Dennis Lockhart said he changed his views about 3-4 hikes this year. According to Reuters on April 14, Lockhart said that to support a June rate hike he would need to see economic growth rebounding fast enough to make 2 percent growth for the year a probable outcome, and continued monthly job gains of 200,000.

"One reason I am let's say supportive of a patient and cautious posture is because I don't think the (Fed) is behind the curve particularly as it relates to inflation," Lockhart said.

 

Hostage to Brexit?

Finally, there is the emerging view that the Fed will not hike at all in June because of the big referendum in the UK the following week. The British are voting on June 23 whether they want to remain in the European Union economic system.

This was expressed in its simplest form by Scott Minerd of Guggenheim who, right after a meeting at the NY Fed, was on CNBC Closing Bell with Kelly Evans and said that the "Fed was hostage" to a macro event with big uncertainlyand potential volatility like Brexit.

Bottom line: If you ever experience confusion (or headache or nausea) listening to all the Fed officials jawboning about expectations, simply look at the CME FedWatch tool to see what the market says about the next rate hike.

Kevin Cook is a Senior Stock Strategist for Zacks Investment Research where he runs the Follow the Money Portfolio.


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