One Fed statement, two divergent readings
It may strike some as ridiculous that trillions of dollars in financial wealth depend on the addition, or subtraction, of a key word from the Federal Reserve's policy statement. Yet here we are.
Such is the consequence of the global economy's still growing dependence on the largesse of major central banks.
On Wednesday, stocks soared for their best one-day gain in nearly two years after the Fed added that it would be "patient" in the timing of its first interest rate hikes -- expected sometime in the middle of 2015 -- since 2006. But more important, the policymakers kept the phrase that these rate hikes would happen a "considerable period" after the end of the bond purchase program that ended in October.
All this seemed to be a dovish surprise.
But other markets read through the smokescreen and responded much differently. Language is, after all, an imperfect and squishy means of communication.
For one, the Fed referenced the "considerable period" language only in reference to its replacement by the new "patient" language. Semantics, I know. But when considered with Fed Chairman Janet Yellen's post-statement comments, it means we could see rate hikes teased as soon as the April policy meeting.
The Fed also dismissed the risk to inflation -- which is running below its target -- from the halving of energy prices over the past six months along with the drop in market-derived measures of inflation expectations. And policymakers left out any reference to recent market volatility -- a change of tack from what they did earlier in the year.
This all seemed pretty hawkish to currency traders, who bid up the U.S. dollar. And it was pretty hawkish to energy traders, who pushed crude oil down well off its intraday highs. Currency traders saw it this way, too, pushing down precious metals after the announcement. Same story with bond traders, who continue to keep pressure on high-yield energy bonds as a wave of production cuts and possible defaults loom.
The explanation probably involves the all-important yen carry trade, which computer trading algorithms have begun to rely on so heavily that on most days, stocks track the movement of the Japanese yen vs. the dollar on a tick-for-tick basis.
If that was the catalyst for today's rebound, it suggests that the bounce -- which is likely, based on technical and seasonality to continue through the end of the year -- will run into new headwinds in early January as the negative consequences of the collapse in oil prices remain in play. In fact, the yen carry trade's desire to see a stronger dollar will only magnify the troubles for Russia and U.S. shale companies.
These include a drop in energy sector investment, a possible slowdown in hiring, pinched S&P 500 profit growth and the very real risk of financial contagion coming out of the high-yield bond market or an oil-exporting emerging-market country. Mix all of this with the very real possibility that the Fed, in response to an ongoing decline in the unemployment rate, starts hiking rates by next summer.
Long story short: The market's schizophrenic response to the Fed news suggests that any rebound for stocks over the next couple of weeks will be only a temporary reprieve from the volatility we've seen over the last two months.
