Fed’s New Mandate

By David Nelson, CFA

Wednesday, the FOMC released the minutes from their September meeting giving stocks their biggest one day gain of the year. If you aren’t sure if this was a Fed induced rally a quick look at the S&P intraday chart is all the confirmation you’ll need.

SPX_Intraday_Oct_8

All of this must be pretty frustrating to shorts or portfolio managers like yours truly who raised cash levels on the heels of a major trend break. Before you put on your party hats the market still has some work to do especially when you dig into the Fed minutes.

They took 13 pages to describe what could have been penned in a paragraph. Two concerns high on their list are weak economic growth outside of the United States and the recent strength of the U.S. Dollar. I’ve been concerned about the rapid rise in our currency as well and have talked about it in several television interviews. The S&P is dominated by large cap multinationals that have a significant portion of their top line dependent on overseas sales. While there are many positives to a strong currency the translation could hit the results of any U.S. company with a large international exposure.

Perhaps the most important part of the release was the obsession with the language. Why are they obsessed with the phrase “considerable period of time?” Because every trader, portfolio manager and economist has a laser focus on the words. We know that once they remove it they are setting the stage for the first Fed hike. Members seem concerned that its removal might signal a shift in policy.

Today’s release has to viewed as dovish and it’s clear Fed hawks Fisher and Plosser have lost this round of the internal debate that’s been building behind the Fed walls.

I’ve taken a look at most of the notes from sell side street economists and they’ve all zoomed in on Fed commentary about sluggish international growth and a rising dollar. Both comments seemed to surprise the street with some even talking about the Fed taking on an additional mandate. CNBC’s Bob Pisani was talking about it yesterday from the floor of the NYSE.

The recent market weakness has centered on deteriorating economic conditions overseas with many investors pointing to Europe. Today’s release calmed those fears. I’m not sure what they can do about it but for now stock investors think the Fed has the cure.

When you put it all together you have to push out your time table for the first Fed hike. I’m certainly not going to stand in front of this freight train so I’m removing my call for a Fed hike by March. I don’t expect a change in policy until about 6 months after a change in language and it seems unlikely at this point that we will see anything this month. That takes you all the way out to at least May.

Earnings season is just getting underway and will set the tone for the rest of October. For complete confidence to return the S&P will have to breakout to another high. In the meantime the Yellen put is in full force with a trailing strike price about 5% below the market highs.