Are they doves or hawks? The FOMC minutes (Federal Open Market Committee -The branch of the Federal Reserve Board that determines the direction of monetary policy) were released Wednesday and we still do not get a clear picture of where rates are going. The minutes we got last week are split and you can feel lines in the sand drawing as some members are fighting for an increase and some still want to stay the course and keep rates near the zero peg.
One thing to keep in mind is that Fed meeting took place before the yuan devaluation rocked world as we reported last week in “Signals.” A line from the report stating: “several participants noted that a material slow-down in Chinese economic activity could pose risks to the U.S. economic out-look” which caused the markets to take it as if the Fed was already considering a Chinese slowdown then the devaluation would be a major debating point for the next meeting and could cause the Fed to pause on a September hike.
The troubling problem is that the “market” had been “rewarding” a delay in a rate hike with increases in the equity market. However after the FOMC notes were released it looks like the hike may not occur in September and bonds, equities and commodities all took a massive beating.
The curve is still pricing in a rate hike in September, but the probability fell from the last report, however most economists still tend to think that the Fed will lift off in September, but the line is fairly well split. After the minutes, the dollar lost ground which would typically give some support to oil and the commodity sector; however the bears just beat down everything in the market but gold Wednesday, Thursday, and Friday.
It would seem that the Fed just can’t win. We talk about it every week, uncertainty drives fear, and fear drives volatility. As traders we love volatility as long as we are on the right side of it, but the fear is that the Fed is handcuffed. China (all of Asia for that matter), Europe, and counties that depend on oil all have the flu, and it is spreading.Because the Fed is running out of tools to fight the flu, the fear is that no matter what happens with monetary policy, America may catch the flu.
The “Signals” cover story on July 27th asked the question, “Are Commodities Pointing to a Global Recession?” As we discussed in the feature article, a commodities meltdown is the first symptom of the flu. Liquidity-driven markets love low interest rates and massive money creation. But low rates cause imbalances (the argument to raise rates), and the bang for each dollar of newly-printed or borrowed currency falls to zero and then turns negative.
What’s happening now as the major economies continue to borrow but can’t seem to turn the proceeds into measurable growth. The world is running epic deficits and monetizing the whole thing, but as a whole the world is not getting the bang for each dollar in returned growth. Basically debt to GDP is soaring at an accelerating rate and it is starting to correct.
As we pointed out back in July, commodities can be precursors of slowdowns. Oil is a high fixed cost industry, once rigs are pumping it is more economical for producers to keep pumping and as global economies slow, demand slows, we get supply glut, and prices fall. We are starting to see the slow down we reported on in July hit the more broad market as fear is hitting the market that it is not a matter of the Fed not raising rates, but a matter that the Fed doesn’t have the needed tools to fight the flu.
In the grand scheme of things a quarter or eighth of a point likely does not really matter, but what matters is the Fed’s credibility. The United States led the world into recession in 2007, the question now is does the Fed have the medicine to get the world out of what lies ahead?
The above article is an excerpt from EQS Trading’s Weekly Publication on the Commodity Markets called “Signals” which we write and publish every Monday. EQS Trading also publishes a daily “Trade Signals” email that provides in-depth “short” and “long” recommendations and trade strategies for the commodity market with entry prices and stop loss levels.
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