“THE LONG SLOW WALK, UNWINDING DEFLATIONARY EXPECTATIONS”……A DIFFERENT GAME

January 15th, 2014 by Leonard

Unwinding Deflationary Expectations

 

 

“The Long Slow Walk, Unwinding Deflationary Expectations.”….A Different Game.

 

Ok, what’s different now, what’s changed in the now tapered market versus the pre-tapered market??………….Expectations.

 

Prior to tapering (before Jan 2014) Expectations were that as long as the Fed continued a bond buying program (QE), that the market would remain stable to higher occasionally getting over heated and lightly pulling back for purchases. That’s been the feel of the market. Bears were never invited to the party.

sad bear

Traders could depend on $85 billion in Bonds and MBS being purchased monthly, keeping stock prices elevated. And that when stocks would fall, some of the money liquidated would go into bond purchases, further depressing rates.

 

Good Game, but that’s over and tapering could play out differently.

 

What do Traders know now??

 

They know that the Fed lowered it’s QE purchases down to $75 billion from $85 billion and that the intent of the Fed is to continue to lower the amount of purchases at a “measured pace”.

 

What does “measured pace” mean going forwards for traders??

 

Seems to me that the Fed is saying that they will lower the amount of purchases by an unspecified amount over an unspecified amount of time. Timing and amounts are going to be dependent on economic activity.

 

Ok, so, that means the Fed is slowly pulling out their proxy support position for stock market valuations. Money will still be supporting bonds as the unwind takes place but it will be smaller in amounts and ratcheted down over time based on the pace of a growing or slowing economy.

 

 

In the past when a few unfavorable economic reports were posted, the market might turn a blind eye and rally based on firming QE program support.

 

But now as the market looks forward to 2014, traders are seeing potentially less support from the Fed, and that might put a cap on rally attempts unless the economy is heated and able to accelerate revenues. How much money consumers spend, will depend on how much consumers earn. The market may want to see faster growing revenues.

 

If we see favorable economic reports some might presume that tapering would increase and come at a faster pace. But that would only be an assumption. And just as I use the word “assumption” I can picture in my mind a more than usual jittery market just before the Feds release the FOMC report with traders placing bets (assumptions) on whether the Fed does or does not taper that month. Can anyone say “volatility”??

Flipping Coin

 

Traders are “feeling out” how they want to play the new taper game. Do we go up on a few strong reports and then run into an interest rate blockade that caps the rally? Do we ignore rates?  Can economic expansion outpace rate hikes? Will breaks in the market be more severe? Will breaks come more frequently? How will the Fed evolve through the unwinding of deflationary expectations? These answers will roll out soon enough.

Janet Yellen

 

I hope Janet Yellen has a thick skin. There are dream scheme plebeians, sophists, and dilettantes posing as congressmen and women trying to get their political claws into the  Federal Reserve to bend and shape the economy to their liking.  It is crucial for the Fed to remain independent…..particularly since the standards for becoming a politician in congress in recent times has been lowered to unprecedented levels of ignorance, and self aggrandizement. What little most Fed haters know about running the Federal Reserve, especially in a global setting might fit into Bernanke’s or Yellen’s little finger nail.

 

We will watch and trade the market, interest rates, and the dollar.  Traders on the floor seem to be raising the bar on what interest rate will cause outright selling in the market. It used to be 3.0% on the 10 year notes. But nothing happened when that level was hit.  Now it appears to be 3.25%. Is that valid? We’ll find out.

 

There is a Head and Shoulders bottom pattern on the daily 10 year treasury yield chart that targets 3.10% as a minimum target projection. Inversely, there is a Head and Shoulders top pattern on the 10 year T-Notes that already fulfilled minimum downside price projections at 123’105 (see chart below)

Double click on chart to enlarge

10 year treasury notes and yields 01-14-14

 

Earnings Season has begun………mostly banks this week along with a mix of manufacturing reports and a couple of housing reports.

 

Barring any unexpected and horrific external events in 2014, I would expect the dollar to eventually go up as interest rates rise and gold falls. The stock market could vacillate in a wide trading range with solid breaks leading to higher prices over time while the economy catches up to current valuations.

 

So far the intraday trading action of the S&P since the beginning of this New Year has been un-inspiring, choppy, and confused. The market has gone nowhere. It will take a while longer for the traders to hook on to a direction and a theme. There should be more guidance on tapering at the Jan 28-29 FOMC meeting. Report falls on Jan 29 at 14:00 EST.

 

The Economy still has a long ways to go to generally catch up to market valuations The S&P should be the winner since it has been the laggard relative to NASDAQ over the last 5 years and who doesn’t like dividends?

 

Be patient and observant.

 

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