Is Fed Fatigue About To Unwind?

September 5, 2014

This possibility is certainly showing in the chart of gold.

As can be seen, gold has been trading in a trying multi-month sideways trend that represents confusion, uncertainty and frustration on the part of investors. 

​It is a product, in my view, of the well-intended and ongoing actions of the Federal Reserve to offset the deflationary aspects of the credit and housing crisis that started as early as the summer of 2006. 

These epic efforts took shadow form in December 2007, strong form in late 2008 and extraordinary form in March 2009 on with the combined and unprecedented result including a prolonged period of zero interest rate policy and $4.4+ trillion of bond buying. 

​Now - and eight years after the housing market’s peak - the Federal Reserve has nearly wound down the last of its three formal bond buying programs known as QE3. It was yet another attempt to stir the animal spirits and grease the wheels of credit.

But in the wake of all of this unparalleled accommodation, the Fed is left not only with a ballooned balance sheet and continued zero interest rate policy but record low velocity of money. 

This means that money is not changing hands very quickly with the system stuck under a stagnant swamp of liquidity that is hindering the possibility of a true economic cycle and something that helps to explain why the economic recovery is so uneven. 

​Clearly, this is a challenging position for the Federal Reserve to navigate from but steer they do and quite well too – thankfully – using the best and probably only policy tool available at this particular point in time or that of communication. Having made the decision to retire its bond buying tactics – for now – and with rates near zero ahead of a possible rate hike, there are few ways the Fed can guide investors to move markets in such a manner so as to achieve its dual mandate.

One way, however, is to lead an all-consuming interest rate hike conversation and one that accomplishes so much in doing so little. First, it implies that the economy is healthy enough to withstand a rate hike. Second, it is friendly to stock investors considering that the possible rate hike is in the indeterminate future. Third, it is flexible to economic conditions, and thus it need not expire. In short, it is all things the Fed needs a policy tool to be in these unusually uncertain times.

​After all, it has been under the gentle sway of subtle changes in language around possible rate hikes that stock indices have found new all-time highs in the face of a tapered bond buying program, geopolitical tensions and an uneven economy.

Clearly this seems more positive than not and it absolutely is. But – it is not without its share of consequences and something that takes us back to the chart of gold.

​Its sideways trend speaks to 16 months of up and down whipsaws that represent the aforementioned confusion and uncertainty first on months of taper talk and now on the unbelievably well-crafted interest rate conversation. Such a trading range is harmless alone, but it represents a contorted, tense, wound up marketplace and one that will return to “normal” when the range is breached. This inevitability happens when all of the pent-up energy is triggered on what is typically massive volatility. 

What makes this sort of a range reaction so challenging is the fact that its direction is often unknown until it happens when it takes many by surprise and without seeming cause.

​This directional ambiguity is very true of gold at the present moment and so much so, it forced me to move to the sidelines early last month on a truly neutral view.

​But gold is not the only asset to have been wound into an increasingly tight coil. This is true too of commodities, stocks, bonds and, most importantly, currencies. All have been trading in ranges of various sorts for at least 12 months with some of those charts starting to suggest that all of this latent energy may soon cause some tremendous multi-asset class volatility.

In fact, one of these ranges has started to come undone already and that is the 10-year yield’s taper talk range. 

​That it should break to the downside in the face of a Fed that has nearly tapered QE3 entirely and is stirring the interest rate hike pot, strikes me as nothing short of remarkable even though it fits with my false initial reaction analysis of that move up last year.

It is my opinion that this continued rally in bonds reflects an early flight to safety and something that is consistent with its ongoing Death Cross as discussed last month with the other side of this eventual equation taking shape as a period of risk-off.

​Such a possibility is consistent with the weekly chart of the Russell 2000 considering that its year-long sideways trend has reversed the QE3 uptrend just as the 2011 sideways trend reversed the QE2 uptrend. The result of that previous gyration is clear: a formal correction.

Interestingly, Fed Chair Janet Yellen highlighted small cap stocks as potentially overvalued and a possibility that certainly matches the visuals of the QE3 uptrend that clearly outdoes the QE2 uptrend and then some.

There is little question, in my view, that the Russell 2000 is moving toward what may prove to be a rather severe correction when its sideways trend finally unwinds. 

​But it is the dollar index that is probably the most direct recipient of Fed Fatigue considering that its technicals have been wound tighter than a spring on Fed policy that pre-dates this year’s interest rate discussion.

Making this possibility truly interesting, however, is the strong likelihood that it will be the ECB’s policy that causes the dollar index’s Fed fatigued range to snap higher in the weeks ahead. This would come, of course, on some sort of a nod toward the ECB’s own bond buying program and one that would be riddled with issues before it was even initiated. 

But ironic as that may be, it is just such a possible spike up in the dollar index that could cause the equally tight commodity coils to come undone on volatility that would likely precede a bearish reaction in the equity markets as well.

It is precisely the potential for this sort of a risk asset sell-off that suggests Fed Fatigue may be about to unwind.


As always, thank you for taking the time to read this month’s piece.

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Courtesy of http://www.peaktheories.com

Gold is using for heat dissipation in some cars.

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