Will the Fed’s Rate Hike Matter?

After two consecutive weeks of treading water, the US stock markets made a decisive move last week—down.  The S&P500 dropped almost 4%, to record one of its worst weekly losses of 2015. Volume was moderate, and volatility spiked….but still not anywhere near panic levels last seen in August of 2015.

The technical charts for the S&P just got a lot uglier. Now that prices have broken down, there isn’t a lot of support beneath the market until the August lows (which were retested in late September) are reached. And that’s about 7% lower than the close on Friday on the S&P. And if that level…about 1,875…doesn’t hold, then the next step down is the October 2014 low of about 1,815.

And this bearish technical development appears to be equally relevant on the daily and the weekly charts. Also, after last week, the 200 day moving average resumed, even if only slightly, sloping downward. And remember, the 50 day is still below the 200 day. Both of these situations are distinctly bearish.

In US economic news, almost all of last week’s reports were disappointing. Labor market conditions, consumer credit and wholesale trade all missed expectations. Initial jobless claims jumped more than predicted. Producer prices, both headline and core, were hotter than expected. Retail sales missed; but retail sales excluding autos beat slightly. Finally, business inventories and consumer sentiment both  missed. In short, we recorded another week of weak data, data that suggests the US economy, which never recovered in the traditional sense of US economic recoveries, is now headed for another recession; the only major questions are exactly when the recession will start and how severe will it be?

Finally, this week, almost everyone is predicting that for the first time since 2007, the Federal Reserve will finally bump up short-term interest rates. And while the Fed has—for a long time—been signalling that this move is coming, and while the markets have supposedly already “priced in” this interest rate increase, there’s a possibility that the markets are underestimating the impact of this seemingly minor increase in rates. Why? Because the Fed’s balance sheet has ballooned by several trillion dollars over the last seven years by electronically printing money (ie. QE), Fed analysts estimate that the Fed will have to remove a lot of money from the rate markets in order to make the itsy bitsy 0.25% rate hike happen.  How much will they have to remove? Estimates range from $300 billion to $800 billion. And the real problem with this removal of liquidity is the speed with which it must happen—virtually overnight.  Remember, the Fed—when conducting its various QE programs—would create and inject several hundred billion dollars over many months.  And this would gradually, but steadily, push up asset prices over that period.

So what happens when the Fed conducts QE in reverse….and in a day, rather than over six months?  Nobody really knows.  But there’s a good chance that even if asset markets have priced in the amount of liquidity withdrawal, they have not fully processed the speed with which it will be withdrawn—overnight, or cold turkey.

On Wednesday December 16, we will find out for sure!

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