Federal Reserve Rate Hike Meeting (June 15th) Preview

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This week we are heading into the Federal Reserve Open Market Committee (FOMC) meeting, where we will likely see a no rate hike decision at 2PM, followed by a prepared statement and then Q&A at 2:30PM.  This is where we expect to see volatility, as investors and traders try to determine when rates will lift off, how much and what the head winds are holding the Fed back.

I think rates should have started to increase in 2011, under Ben Bernanke, but I was disappointed then, and I’m pretty sure I will be disappointed for years to come, as I am starting to believe negative rates are coming before a hike.

The market is implying just a 1.9% chance of a surprise hike of 0.25%.  You can always follow these probabilities using the Fed Watch Futures link here.

What does a no rate hike decision mean for markets?

There will be no surprise if rates are not increased, so a no hike is largely already priced into the market.  However, depending on what Janet Yellen says in the press conference, markets will react to this violently.  If she believes they need to hold rates low for longer (dovish stance), the market will rally, and if she thinks they will continue to hike this year regardless (more hawkish stance), markets will drop.

If equities drop, the US dollar will rally.  If equities increase, the US dollar will drop.

So one way to play the markets this week is as follows:

1. Dovish statement – Long US equities (short US $)
2. Hawkish statement – Long US dollar (short equities)

Market volatility is more prominent in currency markets, but a great way to take advantage of Wednesday’s rate decision is to trade using the SP500 futures, the “e-minis” or “spoo’s”.  These are highly liquid contracts, and provide you amazing leverage to make good money with a small capital base.

Why doesn’t the market believe there will be a hike on Wednesday? (or this year at all)

There are a number of factors that have plummeted the likelihood of seeing an interest rate increase this Wednesday.

1. The British vote to exit the Euro Union (“Brexit”) will take place on June 23rd, just a week after the fed hikes.  If Britain votes for an exit, this will cause unpredictable, but significant impact to the global economy, which can destabalize global markets and throw is in a tail spin at the very worst. The FEd does not want to be responsible for increasing the fear and adding fuel to this fire.
2. We saw a pretty crappy jobs markets, with the Non Farm Payrolls coming out at a 5 year low, matching the worst report since 2011….  the Fed has always said the labor market worries them, and this type of report only helps de-rail their confidence of an economic recovery.  The Fed has said one report is not enough on it’s own, but surely, the meetings are now more tense.
3. The last time the Fed hiked rates, market began an epic slide that resulted in a -12$ return, and the worst start ever to a new year for equities!  This has to be fresh in Janet’s mind – and it probably keeps her up more than she would like to admit.
4. Higher interest rates actually increase the cost of servicing the massive and ballooning government debt.  If the government has to pay more interest on their big debt, they’ll need to issue even more debt to repay their debt payments….
5. Corporations have issued a tsunami of debt themselves, and an interest rate hike now can create a wave of defaults that will throw the economy into overnight panic and recession.  Hedge funds have also used debt to generate assets to invest, which are now down as much as 20%, so that’s a double hit.

When will the Fed be able to finally raise rates?

Never!  Look at what happened to Japan in the 90’s, and that entire history from then until now can be the future for the US and global markets, which have become so addicted to this free money that the addiction will be nearly impossible to break.

Here are a few reasons we think it will be hard to hike this year:

1. Hiking this week is risky, as we are one week away from a Brexit vote and a lot of uncertainty
2. Hiking in July would be too close after a Brexit vote (if they vote to leave) and will add to the uncertainty and fear in the markets
3. Hiking in September and October will get in the way of the presidential elections
4. Hiking in December…well…. they did that in 2015 and look what happened right after? You guessed it…worst historic start to a year for equity markets.  So they’ll be afraid to repeat their mistake… and might as well push that decision to 2016
5. By 2017…we will have fresh worries, concerns and fears of hiking rates, and one quarter at a time we will displace this decision for 2018, then 19…then 20

Will negative rates come to the US before a rate hike?

Yes – plain and simple.  Europe, Japan, Sweden, Switzerland and Denmark have already adopted Negative Interest Rate Policy (NIRP).  We will see a cut to key lending rates in the US in a matter of time.  Forget hikes, here come the cuts!

Why would negative rates be a good idea?

The theory is that they would force banks to lend money, which will end up in consumer pockets, who will spend it and boost the economy and corporate profits.  In reality, it will just force banks to take possession of physical cash and store it in vaults, so they avoid the overnight penalty fee of keeping cash on deposit with the central banks.  So instead of increasing credit and flow of cash, it will have the opposite effects, and destroy bank profits, which can in turn cause a recession at best, depression at worst.

What are pension funds and insurance companies doing?

Nothing, they are getting screwed.  Most institutions have calculated an interest rate of 5% on fixed income products, and are severely underfunded as the capital cannot grow fast enough to pay out claims and/or pensions.  This leads to a draw-down of capital, which in turn earns less return, and depletes the capital base even more.  Eventually, this will result in insolvency and pension funds going completely bust.

What can I do?

You can buy gold, which will increase in value as the US dollar continues to get hammered and drop.  But in the event of a completely apocalypse, what are you going to do with your gold? Eat it? Drink it?  Neither.  You will have to protect it from the guys with the shot guns that will be burning and looting the country.  I don’t think we will get to this doomsday event, despite the fact I do believe we are in for a shock in the financial system in the near future.  I cannot say when, or how it will all go down, but it will most likely begin with currency markets, which will then infect risk assets and take everything down with them.

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The information contained in this presentation is solely for educational purposes, and does not constitute investment advice.  The risk of trading in securities markets can be substantial.  You should carefully consider  if engaging in such activity is suitable to your own financial situation.  TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.