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  1. Home
  2. / Investing
  3. / Financial Services

A Hawkish Fed Still Can't Kill This Market

The market is anticipating higher rates and some inflation and that likely will matter at some point, but not yet.
By JAMES "REV SHARK" DEPORRE
Sep 26, 2018 | 07:47 AM EDT
Stocks quotes in this article: IEF

Ever since the Federal Reserve announced its first quantitative easing (QE) program in December 2008 many bears have predicted that the market would undergo a substantial correction when the program ended and interest rates were allowed to rise again. The logic behind the bearish thesis was simple. If lower interest rates and cheap money helped to drive equity prices higher, then higher rates would drive stock prices back down when those increased rates finally occurred.

The thing the bears were counting on was that the economy would not be strong enough to handle higher rates and that inflationary pressure would ramp up quickly. Unfortunately for the bears neither of these things has occurred. Economic strength has accelerated over the past couple years and there still are few signs of inflation. The unwinding of the quantitative easing programs has not been difficult for the market to handle.

The Fed now has raised interest rates six times in recent years. Goldman Sachs predicts there are six more hikes to come -- two more before the end of this year and then four more by the end of 2020. That means we now are about halfway into the unwinding cycle, yet the market still is flirting with all-time highs.

The Fed is expected to raise rates again at 2 p.m. ET today. That action will be followed by a news conference with Fed Chairman Jerome Powell.

Powell has been more hawkish than his predecessors but continues to repeat that the Fed is "data dependent" and is ready to put interest rates back on hold if there are signs the economy is slowing. Ironically, the uncertainty created by trade issues has made the Fed a bit less hawkish, which has helped to keep the market trending higher.

The big question today is whether another well-anticipated interest rate will matter to the market. One warning sign is that bonds have been inching lower and are now at an important technical junction. The iShares 7-10 Year Treasury Bond ETF (IEF) has been trending down for the past month and now is sitting near the recent lows in May. There is still support but it is precarious, and a break below the May levels will be a big issue for the bond market and will send interest rates to the highest levels since early 2014.

I've often written that the market loves to love the Fed. The Fed cannot do anything wrong as far as this market is concerned. It has straddled the line between being hawkish but staying flexible quite well, but the market is anticipating higher rates and some inflation and that likely will matter at some point.

The point when interest rates really matter to the market is probably not today, but if bonds continue to sink it is going to cause some major concern. The bears have done a terrible job of predicting how higher rates will impact the market, but the thesis is not wrong. The problem is the timing. Few economists expected that there would be this much economic growth this late in the cycle. It has made it possible for the Fed to raise rates without much disruption, but any slowdown will be a big problem if inflationary pressures keep trending higher.

No big surprise is expected from the Fed today, but that doesn't mean there won't be a big move on the news. The computer algorithms will be loaded and ready to run the moment the Fed policy statement is released and we will bounce around on that report. There will be random movement while we wait, but the overall tone of trading remains positive.

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At the time of publication, Rev Shark had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Rates and Bonds | Markets | Treasury Bonds | Financial Services | ETFs | Funds | How-to | Risk Management | Stocks

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