Kinahan: For First Time In Years, Rate Hike Is Truly A Toss-Up

Fed. Fed. Fed. Fed. Did you hear? The Federal Reserve has a meeting this week. And wouldn’t you know it, plenty of stock uncertainty is in the mix. Already, choppy global stock trade colors the week that puts the U.S. Fed—and its hand-wringing interest rate decision—smack in the spotlight.

We know that global economic and market developments likely help shape the chatter for the deliberating Fed. China set a negative market tone there on Monday as another round of disappointing economic data (factory output rose in August but missed expectations) leaves its government’s 7% 2015 economic growth target seemingly further out of reach. But European shares didn’t follow those cues and Europe’s gains could help set up a firm start for U.S. stocks. The U.S. economic and earnings calendar is light to start the week, leaving the mid-week Fed headline the week’s big ticket.

Last week, the broad-based S&P 500 (SPX) logged a 2% gain (figure 1), while the blue-chip Dow Jones Industrial Average ($DJI) rose 2.1%. It was a solid performance considering that higher Fed rates have implications for global profits, business borrowing costs, housing markets, and the relationship between fixed income and equity investments.

Which Way Will They Go?

As recently as early August, the Fed funds futures market was pricing in a better-than-50% chance that the first Federal Reserve interest rate hike since 2006 would come in September. Then, a spate of worrisome Chinese economic data and subsequent stock rout, a washout in global commodities prices, and other factors likely fueled a Fed policy rethink. As this week kicks off, Fed funds futures odds for a September rate hike stand at about 26%.

Predictions are mixed among industry economists, too. A slight majority has said it expects the Fed to hold off, but quite a few consider the decision a complete toss-up. Former Treasury Secretary Lawrence Summers has been a notable voice against a hike just now. But remember, the latest employment report included an unexpected drop in the jobless rate to 5.1% with relatively healthy job growth. The government also nudged up Q2 GDP growth in a revision, now at 3.7%. Inflation? Not a real problem yet.

Even if the U.S. holds pat on interest rates this week (the Fed holds interest rate policy meetings again in October and December), the Fed’s inclination to raise them sooner versus later is keeping upward pressure on the dollar. Few other major central banks are in a position to reverse accommodative policy in their respective regions because of sluggish economic growth. One of them, the Bank of Japan (BOJ), meets to discuss rate on September 15. The BOJ is expected to keep policy steady as spotty data continues to challenge its 2% target inflation.

In Europe, the focus item will be final August euro-zone inflation data due for release on Wednesday. Industry economists think a low reading will feed arguments for the European Central Bank to maintain or even beef up quantitative easing. The Swiss National Bank is also expected to keep policy steady this week, but industry analysts expect the bank to say that it was ready to cut the deposit rate if necessary, according to Reuters.

All told, the global interest-rate differential will keep currency markets under watch. Dollar strength is likely to continue to factor in the U.S. earnings picture, hurting multinational profits.

FIGURE 1: NEW RANGE?

The S&P 500 (SPX) pushed above 1960 as it logged a 2% gain for the week last week. Data source: Standard & Poor’s. Chart source: TD Ameritrade’s thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

FIGURE 2: VIX MOVES NARROWING.

The CBOE Volatility Index (VIX), the market’s “fear gauge,” has slipped below 25 as the broader stock market has steadied. VIX is logging smaller intra-day moves in recent sessions. Data source: CBOE. Chart source: TD Ameritrade’s thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

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Commodities Are a Factor

It could be interesting to see how much lip service the Fed gives to the global commodities retreat. Europe-traded Brent and U.S.-traded West Texas Intermediate (WTI) have declined in 9 of the past 11 weeks.

What’s more, a handful of banks have joined Goldman Sachs in pushing down their crude price expectations. Among them, Jefferies lowered its 2015 forecast on Brent oil by 9% to $54 per barrel and by 10% for the 2016 forecast of $61 per barrel.

Happy Spenders?

As oil drops, so does gasoline. Low gas prices are likely perking up consumers, although their spending has been spotty. The average price for a gallon of regular gas fell 9.8% to $2.44 from three weeks earlier, according to the closely followed Lundberg Survey. But it’s not just consumers that are affected; pump prices are a key driver of earnings at retail chains including Costco (COST, Wal-Mart (WMT), Casey’s General Stores (CASY), and others.

From The Tech Space

Upbeat company news could help start the week off on positive footing. Apple (AAPL) shares were early gainers after a weekend Barron’s article pegged Apple for a 50% gain on its new iPhone program.

Tech deal news also hit. Software firm Solera (SLH) agreed to an acquisition by a Vista Equity Partners affiliate, ringing up at about $6.5 billion or $55.85 per share, about 13% above its closing price on Friday.

These headlines are a reminder that for much of the stock market, it can be business as usual as the Fed does its thing. Sure, the looming rate decision could invite extra volatility that traders must revere (and many will embrace), but higher rates will be the Fed’s endorsement of an improving economy. A well-executed trading plan and a transparent Fed mean there’s little cause for alarm.

Good trading,

JJ

@TDAJJKinahan

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