Connect with us

Politics

Federal Reserve December rate decision importance, stock market impact

Published

on

The Federal Reserve will announce its next rate-hike decision on Wednesday, and the stakes have rarely been higher.

A big part of that stems from the turbulence that’s rocked the stock market in recent weeks. With major US indexes already in correction territory, one wrong step could open the floodgates for more selling.

As a result, the Fed finds itself in a difficult situation. If the central bank signals too much future monetary tightening for the market’s tastes, the 10-year bull market meet its demise. And if the Fed adopts a more dovish tone than expected, there will be speculation that it was been strong-armed by politicians.

But while the December rate decision is arguably the most important in recent memory, equities have actually been taking their cues from the Fed all year, for better or for worse.

Read more:We just got the most alarming sign yet that investors are bracing for a stock market crash

Take the February stock market correction for example. While a big fuss was made about the collapse of an unsustainable volatility trade, ground zero for the sell-off was the blockbuster jobs report for January.

The US economy added way more jobs than expected, and wages rose at the fastest pace in a decade. That fueled speculation that the Fed would hike interest rates at a faster pace than previously indicated, a dynamic that would make bonds more attractive compared to stocks. So equities sold off — and hard.

Then, ahead of the so-called Red October for stocks, Fed Chair Jerome Powell catalyzed another correction, this time with his words. He said the central bank was as “long way” from neutral on interest rates, sparking more concern about a faster path for rate hikes.

But Powell can also be a market ally. In late November, he said rates were “just below” a neutral level, which sent the Dow Jones industrial average surging 600 points, its biggest increase in eight months.

With all of that established, it’s clear that the market will be hanging not just on the rate-hike decision — which is expected by the vast majority of economists to be a 25-basis-point increase — but also on the accompanying commentary.

They’ll devour any bit of guidance from Powell and his colleagues for any hint of what’s ahead for interest rates. And how they interpret those signals will go a long way towards deciding the direction of the stock market through the end of 2018 and into next year.

The Trump factor

The blonde-haired elephant in the room when it comes to the Fed decision is President Donald Trump’s continued insistence upon criticizing the Fed. He’s seen the effect a hawkish Fed can have on stocks, and he doesn’t want the central bank to further destabilize markets.

As such, he’s made a habit out of criticizing the Fed on Twitter, an unorthodox ploy that challenges the institution’s long-standing independence.

Read more: We interviewed Wall Street’s 8 top-performing investors to get their best ideas for 2019

It’s been happening with increased regularity in recent weeks as Trump attempts to exert influence over the Fed’s decision. In late November, the president blamed the central bank for layoffs at General Motors. And this week, he fired off tweets in consecutive days, highlighting low inflation and a strong dollar — two things he thinks should preclude the Fed from tightening at all in December.

Other members of the Trump administration have also gotten in on the action. White House trade adviser Peter Navarro echoed the president’s sentiments on Monday, saying it would be ill-advised for the Fed to raise interest rates just to assert its independence.

There’s no way to know just how much these pressures will impact the Fed. But regardless of what the decision ends up being, the spectre of political influence will continue to loom large.

Conflicting expert opinions

As if the Fed situation wasn’t difficult enough, experts across Wall Street can’t seem to agree on the proper way forward. They also can’t come to a consensus about what the Fed’s plan will be in 2019.

Last week, billionaire investor Paul Tudor Jones argued that current market conditions will keep the central bank from raising rates after a 25-basis-point increase in December.

“There’s a high probability that this hike, assuming they hike, will be the last one for a long time,” he told CNBC in a Dec. 10 interview.

Meanwhile, DoubleLine Capital CEO Jeff Gundlach — also known as the “Bond King” — doesn’t think the Fed should hike at all in December.

“The bond market is basically saying, ‘Fed you’ve got not way you should be raising interest rates,'” he told CNBC on Monday.

Read more:100 BlackRock investing pros got together to formulate a game plan for 2019 — and we got an exclusive look at their 3 big themes for the year

Kate Moore, the chief equity strategist at the BlackRock Investment Institute, doesn’t have a firm view of how the Fed will continue to tighten in 2019. She’s more concerned about what the side effects will be in the market. In her mind, the fate of risk assets like stocks rest largely on the shoulders of the Fed.

“I would say focusing on the Fed, and all of the language and communication they give us over the next couple of months — what their plans are in March and in June, in particular,” she told Business Insider in a recent interview. “I think that will really dictate and really sort of help frame how people think about risk assets throughout the year.”

How to trade the Fed in 2019

The back-and-forth is a lot to absorb, and it fails to answer the main question on the minds of investors: How on earth should you trade this sort of environment? Luckily, Goldman Sachs has an idea.

At the center of the bank’s recommendation for 2019 is its belief that Fed overtightening fears are overblown.

“We think the front end of the US Treasury yield curve is currently underpricing future Fed hikes,” Charles Himmelberg, the chief markets economist and head of global markets research at Goldman, said in a recent note. “In our view, the risk that the Fed gets derailed from its intended path over the next 2-3 hikes is low.”

To that end, Goldman has put together a trade designed to take advantage of a mispriced yield curve.

Ultimately, all of the dynamics laid out above show just how dicey the situation facing the Fed is at the moment, and how small the margin of error will be. Even if the central bank manages to avoid roiling markets in the short term, it will have its work cut out going forward.

Because once the December decision has past, everyone will start looking ahead at the next one. And we’ll get to go through this whole process all over again.

Continue Reading
Advertisement Find your dream job

Trending