FOMC Likely To Soften Tone/Language, Watch Out If Stocks Cannot Rally On This

The FOMC meets this week. A 25-basis-point hike is expected, so is a shift to a dovish bias. Watch out if stocks, beaten up the past two and a half months, cannot rally on this, and/or shorts quickly show up at broken support after a relief rally.

On October 3, the S&P 500 large cap index began retreating from an intraday high of 2939.86 what soon turned into a waterfall dive (Chart 1). Through last Monday’s intraday low of 2583.23, it fell 12.1 percent.

October 3 was also when Jerome Powell, Fed chair, said interest rates were still “a long way” from neutral, suggesting continued hawkish bias in the weeks/months ahead. US equities, which until then had taken the Fed’s tightening campaign in stride, began to fear continued tightening, and began to puke.

Since December 2015, the fed funds rate has gone up by 200 basis points to a range of 200 to 225 basis points. For the last time this year, the FOMC meets this week (18-19), and a 25-basis-point raise is pretty much priced in, with 77-percent odds in the futures market. The dot plot expects three more hikes next year. Equities thus began to worry what credit had been warning all along – can the economy handle all this tightening?

For instance, US capacity utilization came in at 78.5 percent in November, essentially tying August’s 43-month high. The sideways action the last four months comes after rising 3.5 percentage points since the cyclical low in November last year. The cycle high was recorded back in November 2014 when utilization peaked at 79.6 percent. Unlike past cycles, it is yet to cross 80 percent, and likely does not happen (Chart 1).

Throughout the Fed’s tightening campaign over the past three years, the long end of the Treasury yield curve never followed short rates higher in earnest. The 10-year yield has risen since bottoming at 1.34 percent in July 2016 (arrow in Chart 2). Most recently, it bottomed at 2.03 percent in September last year, before proceeding to break out of three percent in April this year. This is about where it also broke out of a three-decade-old descending channel.

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Disclaimer: This article is not intended to be, nor shall it be construed as, investment advice. Neither the information nor any opinion expressed here constitutes an offer to buy or sell any ...

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