Markets have primarily been in “wait and see” mode ahead of the Fed board meeting that began Wednesday and will culminate in an announcement to either raise interest rates or leave them unchanged. Based on fed funds futures, the probability of a September liftoff has been declining. The most recent Wall Street Journal survey of economists showed that 46% currently expect a move in interest rates at this meeting, which is down from 82% in early August.
The survey also showed those expecting an October liftoff in interest rates increased to 9.5% from 3%, while December rose to 35% from 13%. The pace of tightening was also changing, as some speculated that a September rate liftoff could be accompanied by very dovish language.
The U.S. economy has grown enough, and the labor market firmed up enough, to meet Fed officials’ previously stated objectives for increasing interest rates. But the central bank’s key mandate is to keep a lid on inflation, and that measure of consumer and business demand is so weak right now that many experts believe that it fully negates the other factors.
This is a big dilemma for academics, economists and business people because we know so little about how the economy really reacts to interest rate changes. Economists like to think that their profession is a science like physics or chemistry, but at root it is really about psychology, which can be hard to quantify.
Even after decades of study, central bankers will admit they really don’t know how long it takes policy changes to take effect. We do know that Stanley Fischer, the vice chairman at the Fed, was burned by raising interest rates too early a few years ago, when he was head of Israel’s central bank. Later, that bank was forced to pull a policy 180 and cut rates again.
No one wants that to happen in the United States, as it would result in a crisis of credibility. Yet, at the same time, Fischer appears to be undeterred by that prior experience. He is in the camp that argues that the bank will not gain any more confidence about its decision by waiting to lift rates. He has said that you just trade a certain level of uncertainty now for a different level of uncertainty later, which is a very big thought.
Fischer is firmly in the camp that believes there is more to lose by waiting too long to raise interest rates than there is by raising rates too early. By the time you have absolute certainty, he argues, it will be too late and the inflation genie will be out of the bottle and wreaking havoc.
This uncertainty has effects well beyond the boardroom at the Marriner S. Eccles Building in D.C., where the Fed officials meet. The level of interest rates is one of the most important data points that helps investors decide on the level of price/earnings multiples for stocks. This is why the market has been so unsettled…and will be until a decision is made and a rate-hiking course set later today.
In the meantime, the trading will go on.
Bonds were crushed earlier in the week, and should rebound in the next week. The CounterPoint Options system considers bonds to be very, very oversold and is recommending that you buy iShares 20+ Year Treasury Bond ETF (TLT) Oct. $123 calls at current levels around 65 cents.
The ticker symbol for the TLT calls is TLT151016C00123000, and this is the monthly option that expires on Oct. 16, 2015.
Set a target for the TLT calls at $1.05 limit, good till canceled, and use a stop at 40 cents, good till canceled.
By the way, the short Caterpillar (CAT) trade has moved to levels where I want to keep losses in check at just about 2%, so I recommend buying back to cover the short shares and closing the trade.
Jon Markman writes a daily trading newsletter, Trader’s Advantage, and CounterPoint Options, a service geared towards helping individual traders make steady, consistent profits with the VIX. Follow him on Twitter for his latest take on markets and innovation, and be sure to check out his Top Stock for 2015 here.
