#$fed

In the chart above the 30 trading days before and after the last 119 Fed meetings (back to March 2008) are graphed. There are four lines, “All,” “Up,” “Down,” and “Rate Hike Days.” Up means the S&P 500 finished announcement day with a gain, down it finished with a loss or unchanged. In 119 Fed meetings, there have been just 17 rate increases. These 17 increases are represented by Rate Hike Days. Of the 17 hike days, S&P 500 was down 10 times and up 7 times with an average gain of 0.19% on all 17. On the day after the last 17 rate hike announcements, S&P 500 has declined 0.74% on average.

The Fed has already raised rates twice this year and according to CME Group’s FedWatch Tool, there is currently a 100% probability that they will raise rates again tomorrow when their meeting concludes. Up until recently, the Fed was widely expected to raise raises by 0.50, but there is currently (~3 pm est) a 94.5% probability of a 0.75 increase. Regardless of the actual magnitude of the rate increase, the bond market has already done much of the Fed’s work for it already and the opportunity to “get ahead” of inflation seems long gone now.

In one week the Fed will gather for its seventh scheduled meeting of 2019. The Fed has already cut rates twice this year and according to CME Group’s FedWatch Tool, there is currently a 92.5% probability that they will ease another 0.25% next week. In the chart below the 30 trading days before and after the last 93 Fed meetings (back to March 2008) are graphed. There are three lines, “All,” “Up,” and “Down.” Up means the S&P 500 finished announcement day with a gain, down it finished with a loss or unchanged. A green box has been drawn shading the S&P 500’s average performance five trading days before announcement day. On average the period is marked with sideways to flat trading regardless of what occurs on announcement day. Barring any major earnings or corporate disappointments, the market could spend the next five trading days in a narrow range.

Tomorrow the FOMC will meet for the fifth time this year. Unlike previous meetings this year, it is widely anticipated that the Fed will cut its rate by at least 0.25% and possibly as much as 0.50%. Growth, measured by U.S. GDP has slowed, corporate earnings have also slowed, and inflation is running below target, but employment remains firm, risk of recession is not high, and stocks are trading near all-time highs. Ahead of this highly likely cut, historical data has been sliced and diced into numerous different variations. Below we present a straight forward look at the recent history of the S&P 500’s performance following any rate cut.

Since October 1, 1982 there have been 80 interest rate cuts by the Fed (there also was 81 increases). On average, 1-month after the cut the S&P 500 was higher 57.5% of the time with an average gain of 0.77%. At 3-months, the frequency of gains improved to 60% and the average gain swelled to 2.21%. This trend of expanding gains and frequency of gains persisted at 6 months and 1-year after the cut. Of note is since 2001, (dot-com bubble bursting and financial crisis) the impact of rate cuts has not been as strong as it was in the prior two decades.

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In this next chart, we have plotted the average S&P 500 performance 30 trading days before and 60 trading days after a rate cut and a rate increase. Here the initial effects of both a cut and an increase are surprisingly not all that different. In either situation S&P 500 was higher 60 trading days later. A rate cut did have the edge when it came to average performance, but the difference is not all that large.

On Wednesday another Fed meeting will come to an end and another statement regarding monetary policy will we released. As of today, CME Group’s FedWatch Tool is showing a 93.8% chance the Fed will raise rates to a new range of 2.00 to 2.25%. There is also a small 6.2% chance that the Fed raises the range by 0.50%. If the Fed broke from recent tradition and hiked by 0.50%, the market would likely not respond well to the sudden change. Historically down announcement days have been better buying opportunities than positive announcement days.

In the chart below the 30 trading days before and after the last 84 Fed meetings (back to March 2008) are graphed. There are three lines, “All”, “Up” and “Down.” Up means the S&P 500 finished announcement day with a gain, down it finished with a loss. Note how past down announcement days have, on average, enjoyed the best gains over the next 30 trading days.

The fog started rolling in around my home last night and it looks a lot like this as I am writing.  The murkiness got me thinking about how hard it is to find clarity when forecasting, especially with something as complex as inflation.  I do not envy Janet Yellen and her FOMC teammates as they try to look through the fog to forecast job growth, economic growth and inflation.  The major focus lately has been on inflation with the unemployment rate creeping towards historic lows.

So what does Chairman Yellen and her crew see?  They have consistently told us that they expect inflation to move to long run expectations near 2% soon.  But how long can you say soon before it turns into a career?  Some of the messaging is clearly targeted at raising expectations in the market place.  Expected inflation begets actual price rises, is the theory.  But what does the data say?

The chart above shows weekly price changes in the CRB Index, a broad measure of commodity inflation.  It does not cover everything but includes everything you eat, wear, build with and use to transport yourself.  What is it saying?  The chart shows a large run higher off of a double bottom in 2001 to a peak at the height of the financial crisis.  

A swift pullback followed and a bounce to a lower high in 2011.  Since then the CRB index has moved lower, slowly at first then accelerating from 2014 into 2016.  The bounce set up a possible reversal with an Inverse Head and Shoulders Pattern as 2016 ended.  But that was negated with the mid-2017 dip.  Now back testing the prior support area from the double bottom 18 years ago, it is failing to rise again.

A few take aways:  1. Commodity inflation is at historic lows.  Outside of the blip in 2016 you need to go back over 20 years to see these levels.  2.  Commodity inflation is falling, not rising.  3.  Expecting a snapback because it is historically low is not forecasting but guessing.