Oh look, the Fed is back again talking up a rate hike. Man did they come out swinging this past week. Once again they are forcing the market price in a rate hike.
Has the US economy turned a corner? No. Have they hit their inflation target? No. Was Yen strength causing problems? Yes. Was the SPY above 2000? Yes. Do I think the Fed is going to hike in September? No, but the September rate hike’s life depends on a lagging indicator which could make for an interesting trade.
The August NFP jobs number is supposed to come in around 220,000 this Friday. I think that if the number is 180,000+ which seems likely, the market will price in a Fed rate hike much higher than the current 33% chance right now.
That means the dollar will get stronger and US equities should fall. I hesitate to say which direction treasuries would go because any Fed tightening would be bullish for the long end of the treasury curve. The Yen could also weaken initially which would boost the Nikkei.
At the same time, I do not believe the Fed will in the end hike interest rates. For a few reasons. One reason, China cannot handle a rate hike. The PBOC does not want to inject more liquidity into the banking system which would weaken the Yuan.
“A cut to lenders’ reserve requirements would add too much liquidity to the financial system and lead to yuan depreciation expectations, China’s central bank said late Friday.”
If the the Fed hikes interest rates, liquidity would be pulled out of the Chinese economy. The PBOC then would be forced to do what it does not want to do and inject more liquidity via a rate cut to the RRR.
Also, this Fed is incredibly political. There’s a clear favoritism towards Hilary. Donald Trump has publicly said he would replace Yellen if elected. The point is, the Fed will not hike interest rates and risk Trump getting elected… UNLESS Hilary is a virtual lock to win the nomination. Do I think Hillary will be a lock to win the Nomination come September 20th? No.
Recently members of the Fed have discussed the possibility of raising the inflation target as well. Meaning, the Fed is looking for excuses to not hike interest rates. They know the data that they target ie. Jobs, Inflation, GDP growth will tell the market they should hike, but they are constantly looking for reasons to stay put.
Time and time again Yellen has proven to be timid and I think the September meeting will be no different.I do not claim to know the excuse the Fed will come up with this time, but they will find something.
Once the Fed backs off the dollar will fall, the Yen will rise, and the Nikkei will go back into crash mode. If the Fed does hike the Nikkei will also go into crash mode. Either way I think after the market prices in a rate hike over the next two weeks, shorting the Nikkei and being long Yen will be a good trade.
In the end, the Fed’s desperate attempts to force the market to price in a September rate hike could lead to predictable volatility in various asset classes that should be trade-able.