Fed Trick Delivers Market Treat

Posted by Lance Roberts - The X-Factor Report

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This past week, the Federal Reserve, as expected, failed to raise interest rates once again due to ongoing economic weakness and weak labor market results. However, while that meant “accommodative policies” are here to stay for a while longer, it was their forecast that got the “bulls” excited. As Mohamed El-Erian penned for Bloomberg:

Of critical importance to markets is that a decision to raise interest rates for the first time in almost 10 years is now more of a ‘live’ possibility at the Fed’s next policy meeting, in December. In reasserting this policy flexibility and making it explicit, the central bank refrained from providing specifics about the elements that would drive the decision.

The Fed’s message conveyed greater unity among its policy-making officials. Only one member of the Federal Open Market Committee — Jeffrey Lacker, the president of the Richmond Fed, dissented. The near unanimity was an important accomplishment by Chair Janet Yellen, especially given the range of views expressed in the weeks leading up to the meeting, including by the usually united governors.

Many of those in the markets who had grown comfortable with the idea that the Fed would delay a hike until next year are now rushing to adjust. The result will be higher interest rates, especially for shorter maturity Treasury bills, and a stronger dollar.”

The last sentence is the most important. While the “bulls” came piling back into the market (creating a short-covering squeeze late Wednesday afternoon) the consequences of higher rates as noted really isn’t that bullish for stocks. 

First, let’s take a look at the beloved yield-spread which is currently signaling “no recession” in the economy. As the chart below shows, the spread currently between the 10-year and the 2-year Treasury bonds is positive. However, as shown by the dashed red-line, when the Fed starts hiking the short-end of the curve, without economic growth picking up the long end, recessionary inversions can happen very quickly. 



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