As the Federal Reserve policy committee convenes today, the unanswerable questions are stacked high and reach in several directions. “Will the Fed lift short-term rates tomorrow?” is only the most basic starter query and the answer is quite unclear. The implied probability of a quarter-point bump is around 30% based on interest-rate futures trading, but there’s some fuzziness around that number. And this is nowhere close to a forecast that a hike is deeply unlikely:
Coming up “heads” in two straight coin flips has a 25% probability and hardly seems rare. Smart, well-intentioned market experts who spend an enormous amount of time and effort handicapping Fed moves disagree about what the Fed will do, all conceding that no outcome would be all that surprising. Same goes for the other questions down the chain of possibilities: What should the Fed do? If not now, then when? If the Fed lifts its rate target, can it achieve it using untested new tools fashioned in the post-crisis field laboratory? How much does it all matter?
Informed opinion and educated gut feel is all an investor has in grappling with these questions. And then there’s the next-level uncertainty about what the market truly expects, how it will react and what it ultimately wants.
The longer-term Treasury yields have been remarkably steady ahead of this decision, with the 10-year (^TNX) hovering not far above 2%, perhaps a sign that the typically sober, focused government-debt market doesn’t see much difference either way. Tuesday, though, the two-year note surged in yield. This is the paper most sensitive to Fed moves, and its yield hit a four-and-a-half-year high. Is this the market pricing it a rate hike soon?
The heavy wake of some technical trading action? Who knows? Lots of markets get themselves to a sort of neutral, anything-can-happen position ahead of a known potential catalyst like a Fed call. Junk bonds spreads, similarly, have eased back in recent weeks but still reflect weaker credit conditions than a few months ago. And stocks rallied about one percent Tuesday, but merely moved up toward the top of their new, lower range a few percent above the August lows. The best that can be said for the setup in stocks at this point is that investors have rushed to a place of anxiety and diminished expectations, at least hinting that for now a fair bit of potential bad stuff is priced in. Trader and investor sentiment surveys, fund flows, cash holdings in funds and prices paid for options protection have all been flashing contrarian signals that say, “Be ready to buy.”
Nearly ever gauge of investor positioning is the most negative since at least late 2011. Which means, if it’s still a bull market, the risk-reward will turn favorable before too long, right? If… And did Tuesday’s rally burn up some of the pent-up fuel of negative feelings in advance of the Fed meeting? Of course, the market has been contending with more than just the Fed vigil. It’s a net positive that US stocks have stopped tracking every chutes-and-ladders move in the Shanghai (000001.SS) market. But emerging-market stress is no kid’s game. Stocks here are down, but not yet cheap. And seasonal factors remain a headwind for another few weeks at least, if that still matters. Once the Fed decision is in, the game will turn to “What next?” with a couple of well-thumbed playbooks getting passed around. No one wants to miss yet another fourth-quarter sprint to the upside after a messy late summer and autumn. But how long before we all start talking about what has become a perennial U.S. economic “soft patch” in the first quarter? .
Once again, “I don’t know” is the most candid response.
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Feds are thinking of raising the interest rates, but there is no inclination on how that will affect the markets.