Fed Preview – The Good, The Bad & The Ugly

After a miserable August, we’ve all enjoyed a relatively calm market the last two weeks, but unfortunately it’s about to get a lot more volatile again, and we all know it.

Tomorrow brings the most important Fed meeting in years, and whether the Fed raises rates or not is virtually a “coin flip,” which is almost unprecedented.

And, depending on what the Fed does, we could see the declines of August re-appear across asset classes:  Stocks, bonds, commodities, currencies.

The 5+ year bull market is now at a critical tipping point, and whether this market holds or breaks will depend largely on the Fed. 

Understanding the Fed and its effect on stocks is now critically important to client portfolios, because if the Fed does not hike tomorrow, this market could break in a big way, just like it did in August.

Remember, in August the stock market rout began the day after the July FOMC Minutes revealed a Fed that was indecisive, confused and less enthusiastic about raising rates than the market thought.  Those Minutes were one of the key reasons stocks broke down in August.    

But it’s not just about stocks, as bonds have also recently underperformed.

Bond yields hit 6 week highs yesterday despite all this market turmoil, and over the last month clients have seen their stock and bond portfolios decline.

Tomorrow’s Fed decision may have enormous implications for client’s bond holdings as well as their stock portfolios.

So, you need to understand the Fed to protect client portfolios.

We understand the Fed because we spend hours monitoring and analyzing:

  • Comments by Fed officials
  • Research papers from the fed
  • Key economic data the Fed uses to make policy decisions
  • Significant bond market signals that tell us what the market thinks of the Fed and,
  • FOMC meetings and official releases like the FOMC Minutes

We take that analysis and provide our paying subscribers with plain English takeaways they can use to 1) protect client portfolios and 2) seize opportunities.

We are a day away from the most important Fed meeting since the crisis of 2008/2009, and what the Fed does will likely be the deciding factor for whether stocks rally for the remainder of the year, or sell off (potentially violently).

A general recap of the Fed decision that comes out sometime Friday afternoon from your firm’s CIO isn’t going to cut it – you need actionable Fed analysis that can help your clients because markets will already be moving.

That is what we will be providing for paid subscribers of The Sevens Report along with our daily macro analysis of all asset classes:  Stocks, bonds, commodities, and currencies.

We are committed to making sure that our paid subscribers have the timely, accurate Fed analysis they need to:

  1. Alter broad asset allocations if the selloff worsens.
  2. Identify and buy hedges to protect portfolios
  3. Know when it’s safe to expand risk tolerance

Yesterday a strong retail sales report resulted in a big rally for stocks and a steep sell off for bonds, sending longer maturity Treasury yields to near two month highs.

Yesterday’s rally in stocks came as no surprise to our subscribers because we’ve explained, in plain English, that the best outcome for stocks is for the Fed to raise rates 25 basis points tomorrow, and any economic data that makes that more likely (which yesterday’s retail sales report did) is a positive for markets.

On the other hand, if the Fed does not raise rates, then we will likely see the opposite reaction and the question then will become “Will the lows of late August hold?”

Our subscribers will know what the Fed decision means for their client portfolios, and in tomorrow’s Sevens Report (which will be delivered at 7 AM like it is each trading day) we will be providing actionable analysis which will include several ETFs that can:

  1. Hedge against a potential Fed inspired decline in stocks protect client portfolios should we see a repeat of August or,
  2. Rally in the event that the Fed does positively surprise markets and increase rates, which could potentially ignite a powerful rally.

Our subscribers will have that information in tomorrow’s Report and also will have actionable analysis of the FOMC’s decision, and the implication for all asset classes (stocks, bonds, currencies, commodities) at 7 AM Friday morning.

We’ve included an excerpt from the paid edition of The Sevens Report that includes our FOMC Preview.  This was sent to subscribers earlier this week and they have already shared this analysis with their higher net worth clients and prospects, demonstrating to them that they are ready to for any potential outcome from the Fed and have a plan to protect portfolios or seize opportunities.

Click here to start your subscription to the full version of The Sevens Report. 

FOMC Preview – The Good, The Bad & The Ugly (Sevens Report Excerpt)

With the FOMC meeting now just 24 hours away (it’s oddly on a Thursday this month instead of the normal Wednesday) the market consensus is for no hike at the meeting.

And although two-year Treasury yields are at the .80% level that implies a hike thanks to yesterday’s good retail sales data, CME Fed Funds Futures have just a 25% probability of a hike, and the Dollar Index is at the lower end of the 95-97 range. So on balance, market indicators say there will be no hike.

Despite that, the actual economic data fully implies a hike should be coming, and the Fed has for months stated they want to hike. So, the actual decision remains a virtual “coin flip,” because based on their own criteria the Fed should be raising rates Thursday.

Because of this historic uncertainty, we are reviewing three possible FOMC outcomes: The Good, the Bad, and the Ugly.

The Good: Rate Hike and “One and Done.” The FOMC hikes rates 25 basis points and then lowers the “dots,” and uses the Fed Chair press conference to stress that another rate hike is a long way off (well into 2016), thus confirming the “one and done” policy.

Likely Market Reaction: Near-term pain but longer-term bullish. Stocks: Initially a decline because the hike would be a surprise, but we would look to buy that dip.  US Dollar: Initial spike higher, but the 95-97 range would broadly hold near term. Treasuries: Declines accelerate and resistance at 2.20% and 3.00% in the 10- and 30-year yields broken. Commodities: Likely steep declines and the key would be whether the recent lows hold.

The Bad: No Hike but a Firm Commitment to Raising Rates in 2015. The Fed does not hike rates but promises via the Fed Chair press conference to still hike rates in 2015, and perhaps says October will have a press conference after the meeting, putting it fully in play. This is the most likely scenario, and while it would not be positive for stocks for the remainder of the year as the uncertainty would linger, by itself it probably won’t result in a violation of the lows for the year.

Likely Market Reaction: A near-term negative but not a “bearish game changer.” Stocks: Initially a dovish rally but we would look to sell that rally. US Dollar: Spike lower likely through support at 95, but we would look to be buyers in the lower 94 range. Treasuries: Immediate rally, although the yield curve would likely steepen in anticipation of potentially bigger hikes in the future, so beyond the initial reaction this is likely only modestly negative for TBT and other short bond positons. Commodities: The dollar would decline, so a broad-based commodity rally would ensue (gold would be the big winner here).

The Ugly: No Hike and No Further Clarity. The Fed does not hike rates and offers no additional clarity other than vague comments stating that the Committee hopes it can raise rates sometime this year, and that every meeting is still a possibility. This is the worst case scenario because it would increase rate hike uncertainty, and demonstrate the Fed is: 1) Afraid of stock market volatility and 2) Send a terrible signal about the Fed’s opinion on the strength of the US economy. This would be a materially negative event in our eyes and warrant serious consideration of getting defensive in broad allocations.

Likely Market Reaction: Short-term rally but longer-term pain. Stocks: An initial dovish rally but we would sell that rally and use it to de-risk, as our view of the Fed would be materially downgraded. US Dollar: Spike lower through 95 and likely 94.  Treasuries: Higher across the board.  Commodities: Sharp rally on a declining US dollar (good for DBC).

Bottom Line

The “Bad” scenario is the most likely outcome, and while it will likely be a short term negative, it won’t rule out a rebound in stocks later in the year. However, with the added uncertainty will become a heavier weight on the markets going forward.

The Sevens Report is not a market recap.  It’s a daily macro report that provides actionable analysis to help financial advisors navigate an increasingly difficult market. 

Our Fed analysis will explain what the Fed decision means for each asset class, and provide our take on what the Fed means for general asset allocations, tactical investment strategies, and whether investors need to get more defensive.

Getting the Fed decision “right” may very well be the key to outperforming for the remainder of 2015.

Make sure you have an independent analyst team working for you that is committed to helping you succeed for the rest of 2015.

Click here to start your quarterly subscription for $65/month ($195 total). 

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Best,
Tom

Tom Essaye,
Editor of The 7:00’s Report

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