The Federal Open Market Committee (FOMC or The Fed) meets eight times a year. At the end of these two-day affairs, precisely at 2 p.m. the “Statement” is read, preceded by a one sentence report on whether or not interest rates (the Fed Funds Rate) is changed.
Unless a surprise happens with the interest rate announcement, traders and analysts look to the language contained in the Fed’s page and a half statement for indications of the august body’s thoughts on the health of the economy, and what they might be doing with monetary policy in the future.
It’s such a popular thing to do, that many financial sites post marked up documents comparing the previous and current statements word-by-word.
I believe it would be useful for us to see why the global markets have traded up since the Fed released their most current statement.
Let’s take a quick paragraph-by paragraph review of the document and translate what the Fed-speak really means…
- Economic activity changes from solid to moderate – that’s a step-down, and a is a negative for maintaining inflation at an appropriate “Goldilocks” level of not too high or too low. *Meaning: This is the first factor that hints at a higher probability of future interest rate drop.
- Instead of slowed household and business fixed investment spending, household spending actually went up while fixed business investment remained soft. *Meaning: This one is a coin flip, one item hurting and one helping the chance for a future rate drop.
- Inflation compensation declined further from being already low. This is one of the strongest statements of worry about how inflation is too low. *Meaning: The Fed’s remedy for inflation that is too low is to lower interest rates.
- They see inflation “near” the desired two percent level, but they added that uncertainties that they could keep inflation up near 2 percent increased. *Meaning: There’s more concern about keeping inflation high enough to keep from slipping toward deflationary pressures.
- Next they used the same language from the surprise statement of two weeks ago: “the Committee… will act as appropriate to sustain the expansion”. *Meaning: This is not as strong as European Central Bank head Mario Draghi saying they would do “whatever it takes” to keep expansion rolling, but it’s still shows the FOMC’s willingness to lower rates or take other actions to “spike the monetary punch bowl” to fight potential deflation and keep the economic expansion rockin’…
- The ever-dovish (in favor of monetary stimulus) James Bullard dropped from the ranks and voted for a interest rate drop now. This shows further the growing sentiment that the FOMC will raise rates soon.
To that end, the tool that the Chicago Merchantile Exchange (CME) uses to track institutional hedging activity against a rate drop or hike (essential when institutions use futures contracts as a form of portfolio insurance) shows a high probability for a rate drop in July:
In this chart, you can see that institutions are showing a 0% chance that the Fed will leave rates the same at the July meeting! Compare to an 84.7% probability of the rates staying the same through July as recently as May 21.
It is this optimism for monetary stimulus that has the market hitting all-time highs (along with Presidents Trump and Xi playing nice this week).
We’ll continue to watch the Fed’s comments leading up to the July meeting, but for now, pullbacks are still to be bought.
Great trading and God bless you,
D.R. Barton, Jr.
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