foxex: Fed is Skittish About Economic Growth

Chart Advisor | Focus on the Price

By John Jagerson, CFA, CMT

Wednesday, February 20, 2019

1. Fed minutes reveal uncertainty

2. Emerging markets continue to look better

3. Short-term focus should shift to economic indicators

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Major Moves

The Fed released the minutes from the FOMC meeting held on January 19-20th this afternoon at 2:00 PM Eastern. The release was a little out of the norm because a storm had shut down many government offices and workers were home, which prevented the Fed from releasing the minutes to news organizations early. Releasing data to financial journalists and traders at the same time runs the risk of misinterpretation and volatility as everyone rushes to publish without enough review.

I always get a little nervous about announcements from the Fed that deviate from the normal procedure. It's a small thing, but it wouldn't take much to trigger a "flash crash" in the markets now that the S&P 500 has risen (virtually uninterrupted) 18% off its lows. However, despite some back and forth trading, volatility seems to have remained under control.

The Fed's minutes were focused on rationalizing a pause in interest rate hikes and why the Fed should refrain from reducing its $3 trillion balance sheet further in 2019. Members of the FOMC are concerned about slowing in China and that the FOMC's own actions have introduced uncertainty in the market. While I read the statement, I ran a search for the term "patient" which appeared 13 times; that makes it clear what the Fed is trying to convey to the market.

S&P 500

From a technical perspective, the S&P 500 is creeping up to the price associated with the top of the channel before December's crash. It's too early to say if this will turn into resistance, but it is a possible candidate. In my view, if there is a pause, the catalyst would be the Fed's dovishness.

Stock returns and interest rates are usually positively correlated. If long-term interest rates continue to decline (like they have been since January 18th), the Fed's lack of confidence in the economy could be just the excuse traders need to take some short-term profits off the table.

To be clear, I still see the underlying fundamentals as very supportive of the market in the intermediate term (3-6 months) so a short-term pause is more interesting as a dip-buying opportunity than anything more serious.

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Risk Indicators - Emerging Markets

As I mentioned in yesterday's Chart Advisor issue, gold, bonds, and stocks have been rising together recently. This correlation isn't common and indicates that investors may be hedging their stock portfolios as valuations become extended in the short-term.

Today's reaction to the FOMC minutes wasn't dramatic enough to provide much additional insight into this unusual correlation between risk-on and risk-off assets, but there are other indicators that can fill in a few details.

As I mentioned last week, emerging markets have been wishy-washy after most emerging market indexes completed a bullish double bottom pattern. However, the decline in the U.S. dollar over the last week has relieved some pressure on emerging markets and momentum appears to be building.

A falling dollar is good for emerging markets because it reduces inflationary pressures and helps those economies hold onto investment dollars that might otherwise leave to invest in US dollar denominated assets. As you can see in the following chart, as the dollar has been falling (blue line) the Shanghai Composite Stock Index has been rising: that confirmed a retest of the recent double-bottom breakout.

From a risk perspective, emerging markets are a good bellwether for investor sentiment, so this is a positive development over the last few days. If the USD's decline continues, the rally in emerging markets could go a long way towards minimizing any downside in the S&P 500 if the major indexes stumble at resistance.

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Bottom line: Focus on economic data

The days the FOMC meetings are held or FOMC minutes are released normally have an erratic trading pattern, so what we have seen today isn't particularly worrying. Now that most of the 4th quarter earnings reports are in, the focus over the next few weeks will likely shift back to economic reports and the ongoing tariff war between the US, China, and the European Union. Durable goods orders are due for release Thursday morning; that should also give us insight into whether the outlook for industrial production will continue to improve or become more fragile.

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