The Federal Reserve signaled an interest rate next month while the stock market shows signs of technical weakness along with crude oil and junk bonds. Sounds like 2015?
Except for one thing. There’s something happening Tuesday, what was it? Oh yeah, an election.
To the surprise of absolutely nobody, the Federal Open Market Committee voted to hold interest rates steady at the end of their two-day meeting Wednesday while deciding the case for a rate hike “has continued to strengthen.” Without putting a timetable on that—as the FOMC had ahead of its initial one-quarter percentage point increase last December—the federal funds futures market placed a 78% probability of a similar move next month, to a target range of 0.5%-0.75%.
The only slightly unexpected change was that there were only two dissents on the FOMC instead of the three at the previous meeting in late September. Esther George and Loretta Mester, presidents of the Kansas City and Cleveland regional banks, again called for an immediate rate hike while their counterpart in Boston, Eric Rosengren, withdrew his objection to standing pat this time.
The latter’s “amazing flip-flop” drew the ire of Peter Boockvar, managing director at the Lindsey Group, which he attributed to the presidential race. “Bottom line, the Fed is obviously political in their decision to not hike rates today. Rosengren is the most blatant example. The Fed did not want to take any risk whatsoever in causing a market selloff of substance over the next week which would tip the election,” he wrote in a note to clients Wednesday.
Not that is unexpected. Investors are feeling the effects of the tightening of the presidential polls in recent days after having focused more on down-ballot races previous, wrote RBS Treasury strategists Blake Gwinn, Brian Daingerfield and John Briggs. “That theme continued in force today as the level of angst over a surprise Trump victory seemed palpable.”
The sharp swing in sentiment was reflected in various presidential opinion polls showing the gap between Donald Trump and Hillary Clinton narrowing. JP Morgan rate strategists also pointed to a huge swing in the Iowa Election Markets, which saw the probability of a Republican president soar 33 percentage points, to 43%, while that of a Democrat falling 31 percentage points, to 59% (with rounding, obviously). The odds of a GOP Senate and House jumped 27 percentage points, to 34%, while that of a Democratic Senate and a GOP House fell 29 points, to 36%.
Politics largely overshadowed the Fed. Along with further falls in oil prices, U.S. stocks dropped Wednesday for the seventh straight session, their longest losing streak in nearly five years. At the same time, Treasury yields receded from their recent highs while precious metals moved up—signs of investors’ risk aversion. Other indicators of the same: the Russell 2000 index of smaller stocks sharply underperformed, losing 1.2%, almost twice the drop in the Standard & Poor’s 500.
Given the swing in the presidential polls, the JPM strategists wrote they were “not surprised that Clinton’s loss of momentum has caused risk assets to underperform and Treasury yields to decline. Trump’s fiscal platformsuggests a sharp increase in debt-to-GDP ratios and would be negative for Treasuries over the medium term, but we continue to think the near-term implications of anti-trade rhetoric coupled with a more caustic tone toward international relations could connote negative growth implications, which would push the path of Fed tightening back and lower Treasury yields.”
That political scenario remains hypothetical at this point, to be sure. But regardless who occupies the White House starting next Jan. 20, the path of future Fed rate hikes is apt to be a gentle upward glide. The fed funds futures market Wednesday was pricing in just under even money (a 47% probability, to be exact) for an increase by December 2017 to 0.75%-1% or higher. In other words, next year should be one and done for the Fed, just as 2016 is expected to be and as last year was.
Independent economist Steve Blitz says the Fed is in no hurry to steepen the yield curve (that is, widen the difference between short- and long-term rates.) A quarter-point hike in short-term rates will give a negligible lift to savers but 10-year yields matter more.
Expectations at the beginning of 2016 for four rate hikes battered the markets, with the rising dollar further battering oil and in turn hitting the energy-heavy high-yield bonds and the stock market. The rout ended when the Fed backed off from rate hikes and (it’s suspected) major central banks worked to stem the greenback’s rise in late January.
But at this point, next month’s FOMC meeting seems ages away—especially when all anybody can think about is Tuesday’s elections.