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Update on the FOMC and Interest Rates

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What if the Fed DOESN’T Raise Rates?






 By Michael A. Gayed CFA


With odds high for the Federal Reserve’s first rate hike in nearly a decade, and seemingly everyone predicting that rising rates are coming in the next few weeks, why in the world is the yield curve not steepening aggressively?

Something curious is happening

There is a mistaken notion out there that if the Fed raises rates, the cost of capital on everything is going to rise.  This is far too simplistic a way of viewing the bond market.  If the Fed raises rates and the market perceives it as being too early, then longer duration bond yields likely would actually fall and credit spreads likely would widen.  In other words, some rates could fall because the Fed is raising short rates.




In a healthy environment, Fed hiking would coincide with a steepening yield curve, as growth and inflation expectations become more aggressively priced in. As of late, it seems as though the bond market vastly disagree with the Fed’s December timing.

Of course all this could change, as probabilities continuously change

So, if the Fed decides not to raise rates, and the yield curve continues to flatten, then something very serious may be underway in terms of 2016 economic expectations.  It does seem plausible that from a cycle perspective, the era for passive buy and hold investing in large-cap stocks is nearing its end, allowing for more active alpha opportunities to present themselves.

This would likely translate into more volatility in equities, which we believe our alternative Morningstar 4 Star overall rated ATAC Inflation Rotation Fund (Ticker: ATACX, rating as of 9/30/15 among 234 Tactical Allocation Funds derived from a weighted average of the fund’s 3-year risk-adjusted return measures) is distinctly qualified to handle given our focus on being defensive in Treasuries at the right time.

Having said that, despite my own personal believe the Fed will raise rates, it is concerning to see how longer duration bonds are behaving.

The key needs to be a comeback in commodities and emerging market stocks

For the yield curve in the United States to steepen, and for the Federal Reserve to “get it right,” likely a surprise recovery is needed in cyclical growth sentiment.  Commodities and emerging markets are among the most sensitive areas of the investable landscape to that, so it stands to reason that their movement would show the whites of the eyes of that happening.  The issue however is that every time is looks like budding momentum is about to become more entrenched, that momentum quickly reverses and creates a false positive on rising growth expectations.




Recent manufacturing data confirms that not much has changed on the growth side of the equation.  So far, broader equities seem to not care given historically favorable December seasonality.  That doesn’t mean one should not be considering this in an overall asset allocation policy.

Complicating-The European Central Bank

In many ways, crushing the Euro through more stimulus has the same effect as Federal Reserve tightening precisely because a rising Dollar is a contractionary force to exports.  European stimulus is Fed tightening IF it results in a Dollar super-spike.  Should that occur, the Fed would be more likely that not to not raise rates and actually do another round of stimulus.


Insane sounding?  Maybe.  But; so is an environment where no amount of money printing seems to be accelerating the economy.


The ATAC Rotation Mutual Funds are managed by Pension Partners, LLC, an independent registered investment advisor.  The strategies were developed by Co-Portfolio Managers Edward M. Dempsey, CFP® and Michael A. Gayed, CFA. The Funds rotate offensively or defensively based on historically proven leading indicators of volatility, with the goal of taking less risk at the right time.


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5 Responses

  1. FED quiets ahead of hike?

    After several days of wild volatility, the stock market may use the coming week to catch its breath, as it waits for the Fed to end the historic era of zero interest rates later this month.


    Clem Sohn


  2. Don’t Assume a Fed Action Will Move the Market

    The Federal Reserve is almost universally expected to raise rates this month, but according to ROBERT J. SHILLER, human nature makes it hard to predict what effect that will have on major markets.





    As the world “prepares” for the first Fed rate hike in nearly a decade, it’s time to rethink monetary policy and the wakening monster of short-termism.

    We have been vocal for the past month in our writings and media appearances that the Fed likely will raise short-term rates this week. Arguably, the economy appears strong enough to handle higher rates, however the market may not be. Headlines focusing on the carnage in junk debt have gotten quite a bit of attention as two major funds halt redemptions because of severe illiquidity and stress in high yielding bonds. Major high yield bond mutual funds are now attempting to do damage control to keep investors from panicking and creating a self-fulfilling cycle of fire-sale bond prices, but none of this may help to stem what could be a growing crisis. In a world of tremendous liquidity, it turns out there is actually very little when short-term momentum chasing results in everyone being a buyer, and a seller, all at once.

    The revelation of such severe illiquidity could very easily result in the Federal Reserve NOT being able to raise rates this week. The reasons for this relate directly to the possibility that a rate hike now becomes perceived as a policy error, increasing the cost of short-term capital at a time when credit spreads are blowing out. Herein lies the irony of where we are and the absurdity of the current environment appreciated by so few. The Federal Reserve created an environment where yield chasing became the secular reason to buy anything that had income attached to it, simply because there’s “nowhere else to go.” I have traveled across the country presenting to Market Technicians Association and Chartered Financial Analyst (CFA) Chapters and met with thousands of financial advisors. The love for yield and income, as well as significant over-weights to the fixed income space are not just hearsay but a pervasive and systemic theme which can unwind in a brutal way. In a world where it is so easy to press a button and sell in order to satisfy emotional fear over the unknown future, there are few other buyers on the other side.

    Now, the Fed must try to figure out a way to increase rates just as the bond market appears to be in a highly fragile position. Can words alone do this under the idea that Yellen can create a “dovish” Fed rate hike? Maybe, but I question the effectiveness of this and reaction by the market. After all, Draghi the day after the ECB’s expansion of Quantitative Easing tried to reinforce the idea that the central bank has the ability to do more and will act as needed. Last I checked, European stock markets and the Euro are calling that bluff. The Last Great Bubble – faith in central banks – is slowly beginning to pop, and this is a long-term secular trend all asset allocators and anybody invested in markets needs to be aware of beyond the small sample of market movement yesterday, today, or tomorrow.

    The Fed created a monster of a situation here. By overly talking about raising rates, the market front runs them by selling risky debt. The Fed, however, has likely massively underestimated just how far the reach for yield has gone as anybody invested in high yielding energy MLPs can attest to. Now, with it time to finally raise rates, the Fed’s credibility is on the line whether they decide to raise or not raise rates because of the unwind of that one-sided trade they encouraged. In their obsessive short-term focus on which meeting rates will rise, central bankers have encouraged short-term liquidity panic potential which in turn can halt all “progress” made under a zero interest rate policy.

    Too often people forget that the market is bigger than the Fed. The long end of the Treasury curve does not appear ready for a hiking Federal Reserve given flattening into the decision and credit stress in junk. Will the Fed finally rip the band aid off? While we will find out this week, the longer term question is how normalization can occur when short-termism dominates investment decision making both up, and down in asset prices.

    The continuous jawboning by central bank officials has only exacerbated the monster of short-termism. It is that monster which makes the long-term outlook for financial markets bleak.

    Michael A. Gayed CFA
    [Portfolio Manager]


  4. FOMC and Oil

    Not a day goes by where Oil and Oil related ETFs like the United States Oil Fund, LP (USO) aren’t referenced in financial media. I can think of no other subject matter which gets as much attention in markets with the exception of Federal Reserve policy. The funny thing about Oil price movement is that it can be used to justify anyone’s bullish forecast about the economy and stocks in the future. Oil prices are up? Must be because the economic demand is strengthening and global growth is picking up. Oil prices are down? Well that’s more money for the consumer and should result in more spending to come. No matter what, ETF buyers in the popular S&P 500 SPDRs ETF (SPY) likely will use Oil’s movement to justify their purchases.

    There is some truth to both paradoxical statements, but Oil prices largely have little correlation over the long term to stock price movement. Still, it does make for great conversation and allows the imagination to run wild about different scenarios. The reality is that steady Oil price movement is much more important than Oil level, allowing marketplace participants to adjust accordingly. When Oil collapse, it puts credit at risk and increases the potential for default by energy companies. That brings risks of contagion in the bond market. As Oil prices rises, that default risk fades and allows for a potentially large price re-adjustment by equity investors on the value of various energy stocks.

    Crude Oil has had its longest streak in history below its 200 day moving average, and that historic move appears close to ending. That does not, of course, mean that prices will hold or push higher. Certainly Oil’s downtrend may simply be pausing. However, with bearish sentiment as extreme as it has been, at the same time emerging markets appear to broadly be recovering, the odds favor stabilization at a minimum. Into this quarter, our top quartile ranked ATAC Beta Rotation Fund (Ticker: BROTX, Morningstar ranking out of 1,525 Large Blend Funds for the one-year period ended 3/31/2016 based on total returns) will be overweighted the Energy sector (XLE) based on our dynamic momentum weights and risk triggers. While our strategies are purely quantitative in nature, personally given everything I’m seeing that “feels” like the right trade to make.

    There is a dilemma here though. Stabilization and even an uptrend in Oil would accelerate the potential for cost-push inflation as expectations for rising prices increase on the market level. Looking at Fed Futures, the market has a hard time believing the Fed will raise rates at all this year, and dovish speak by central banks appears to confirm this. Why does this matter? Because it increases the odds of a reflationary correction at some point this year, whereby the market believes the Fed may actually be late to the game and have to raise rates in a sudden way. The market loves a Fed which is late to the game of raising rates, but hates hike shocks which Oil may be a source of.

    Of course, market movement has millions of paths, many of which are unpredictable. The path of least resistance for commodities appears to be higher. Those tracking the Market Vectors Gold Miners ETF (GDX), and the SPDR Gold Trust Shares ETF (GLD) know just how violent commodity movement can be. A more aggressive move in Oil of similar speed may be much more problematic for the Fed then even the Fed realizes. Volatility, I believe, is far from over in both directions. The frequency of which may become even more historic.

    Michael A. Gayed CFA


  5. Fed Chair Pick Praised by Bond Managers

    According to David Armstrong, Jerome Powell is the “smart choice” to chair the FOMC, as he spoke to bond managers gathered at the Inside Fixed Income conference.




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