Tomorrow at 2:30 Eastern Time, the U.S. Federal Reserve will hold its press conference that will announce its monthly decision. This meeting is especially crucial due to whether the central bank will increase interest rates or not. Most particular in investor curiosity is guidance, or language of some sort. From the Fed suggesting when the inevitable rate increase will likely occur, to when it might not occur, are the signals. That is, will the interest rate increase happen this year or next, or this Spring or Fall. Also of note are indications of under what circumstances a rate increase might occur. These matters are of considerable import in bull/bear market debates.
Where the Fed has been using a word, being "patience", on their timing of increasing interest rates, market consensus is that the Fed will eliminate the word "patient" from their often elusive "message" to the markets. The entire question does reside in how the Fed fills the hole left behind from abandoning "patient". Does the Fed replace the idea of patience with "light this candle" and rush interest rates (unlikely, they look like s.m.art.). Or does the Fed say they are going on light throttle touching increases, to see how the ship flies. Or, do they speak with a big stick and walk lightly with a month to month review of interest rate increases. This approach would really be learning how to fly through this unprecedented valley of history.
Ultimately, given the rise in the U.S. dollar and the rise in U.S. equities, the Fed needs to disappoint both asset classes. Increases in the U.S. dollar have been untold for nearly a half century. The rise in U.S. equities produce a consensus regarding a needed correction of considerable depth outside of channel up trajectories. Look at IPO's (especially among technology companies), falling earnings projections, sustained stock pricing, and challenges to revenue quality.
Small capitalization stocks see a weakness as well. How many services do these small cap companies offer to the employees of big capitalization companies? Or, how many services do these small caps offer to the big caps? Or, how many small caps are looking to be acquired by a big cap? These are drip down feelings for small caps, if big caps get hit too hard with our global environment.
To further make the point, for a big cap company to appropriately acquire a small cap, a condition of health should exist in the big cap. Consequently, a disturbing condition would occur should a big cap start acquiring small caps to help hide global weakness produced by dollar strength and declining global demand. By the way, dollar strength and weakening global demand are trends that don't look very transitory, unless the Fed acts to arrest the dynamic in some fashion.
Looking at actual influences on Fed decision making, perhaps a look at the last CPI data will help on perspective.
Strongest perspective is to say that while the headline CPI from the BLS for January, last reported on February 26, 2015 was -.7%, and for the year ending January it was down -.1%. But the story isn't over. Food for the months of July to last December held a run rate of price increase in the area of .3% to .2% and found a flat .0% in January, 2015. Overall, for the 12 months ending this last January, the rate of price increase for food resulted in 3.2%, well above a 2% Fed mandate. Out side of energy, most elements of the CPI increased more than 2% for the 12 months ending January. The increases beyond the Fed's 2% inflation mandate are:
Home food ending 12 months January increasing 3.2%.
Away food ending 12 months January increasing 3.1%.
Medical care commodities (same period) 3.9%
Shelter (same period) 2.9%
Transportation services (same period) 2.1%
Medical care services (same period) 2.3%
How about this versus petroleum, natural
gas and coal 's substantial decline: (shocked by this)
Electricity (same period) 2.5% (increase)
Keep in mind, energy in general has declined over the last year from 20% to 35%, depending on products. The meaning to be taken is that petroleum prices are essentially the only element that prevents the Fed from exceeding its inflation target of 2%. Last Fed meeting, Chair warned of "transitory" energy prices...meaning petroleum and gas. These two elements are children on the play ground of where the reality exists.
I've heard every day for the last 3 months about a bottom for petroleum, or no bottom. Petroleum is in a transitory dynamic driven by its own market cycle, which is a new cycle given U.S. production. Consequently, petroleum's influence on inflation can, and will, change based on that sector's response to the market.
These facts show the importance of the service industry in the U.S. and its association with the real U.S. economy. Looking at BEA reports, services in the U.S. have exceeded goods in sales by about 50%. Further, most of the above GDP areas that are exceeding 2% inflation are service industry related. Consequently, most of the U.S. economy is motoring above 2% inflation. It's only when one factors in giant drops in petroleum that one sees a muted disinflationary environment. Taking out the oil influence, the U.S. is experiencing a level of inflation generally well above the target of 2%.
Why oil is transitory are common and daily debates on where, when, who and at what consequence any price of oil will be realized. These debates could finally be realized on the side of inevitable market stabilization. Any stabilization will probably be increasing petroleum costs, that add to existing inflation that already exists through other areas of the economy. Overshooting the target by the Fed is their risk at this point. After all, petroleum is going through a cycle that will be self-correcting by its own giant market, without the Fed raising or lowering rates.
Where Fed Chair Yellen mentioned transitory energy prices in terms of interest rates, it appears real. Tomorrow's announcement seems to be setting up to be more aggressive than just removing the word patient. More like, see how the motor works on an aircraft never having reached this elevation.
Reality is, the U.S. dollar needs to be disappointed by "not enough", equities need to be disappointed by "too much", and bonds need to hold ground by warming up to their month long yield increases. At least until the Fed's next review of circumstances. Perhaps, if the buck gets talked down a little, with enough doubt on movement, equities will perhaps respond. Bonds can be let down at their choosing in their own confusion. Let's see how it plays out.
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