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September 18, 2017

How Much Longer This Stock-Market Bull Lasts May Depend on Fed’s Next Move

Alaric Securities

All eyes on Yellen as the stock market awaits Fed’s two-day meeting.

Wall Street investors have shrugged off recent worries to propel stocks to fresh all-time highs, but this week’s meeting of Federal Reserve policy makers might provide investors the clearest sign yet about the health of the U.S. economy and how the central bank is construing stubbornly low inflation.

The Fed gathering set for Tuesday and Wednesday comes against the backdrop of a host of recent events that market participants are anticipating will factor in policy maker’s decision making: The economic impact of Hurricanes Irma and Harvey, sluggish inflation, the outlook for fiscal stimulus out of Washington, may be a just a few of the topics that are broached. (That is not even to mention the incalculable risks out of the Korean Peninsula).

Although Janet Yellen’s Fed isn’t expected to make any change to interest rates, it is anticipated that it will lay the groundwork for unwinding its $4.5 trillion balance sheet, if not announce its start. The coming asset-portfolio reduction has been an important focus for markets because of the unprecedented nature of unraveling a nearly decadeslong initiative of monetary stimulus, which could further tighten borrowing costs for individuals and corporations.

Yellen is likely to emphasize that normalizing the balance sheet is going to be gradual so as to avoid disrupting markets, said Paul Ashworth, chief North American economist for Capital Economics.

The plan is to shrink by only $10 billion a month, with the pace increasing by $10 billion every quarter, up to a maximum of $50 billion a month.

Bond and currency markets, which have been the most attuned to Fed policy, will experience the greatest degree of volatility if there are any Fed surprises.

The yield, which moves inversely to prices, on the 10-year Treasury note TMUBMUSD10Y has climbed to around 2.21%, compared with 2.05% on Sept. 11. The U.S. dollar DXY has also reclaimed some lost ground. However, both the dollar and yields remain near historic lows despite being in the midst of a rate-hike cycle that should theoretically buoy the pair. Higher rates make the buck more attractive to traders, while pushing up yields on bonds as investors await fresh issuance bearing richer coupons.

Some market participants attribute a combination of fluctuating risks centered on North Korea’s military aggressions, and fading expectations this year for the pro-growth policies promised by President Donald Trump during his presidential campaign. Political doubts have been underpinned by increased partisan tension, though a glimmer of bipartisanship has offered some promise of successfully pursuing tax reform, deregulation, and increased infrastructure spending in the coming months.

Some of that hope has filtered into stock markets, with the Dow and S&P 500 logging record closes and the Nasdaq narrowly missing a record of its own on Friday. The Dow Jones Industrial Average DJIA rose 64.86 points, to 0.3%, to close at 22,268.34, logging its fourth straight record close and its sixth consecutive day of gains. For the week, the blue-chip gauge booked a gain of 2.2%, marking its best weekly advance since the week ended Dec. 9, according to FactSet data.

The S&P 500 SPX ended 4.61 points higher, a return of 0.2%, at 2,500.23, while the Nasdaq Composite Index COMP rose 19.38 points, or 0.3%, to close at 6,448.47, missing an all-time high by about 12 points.

Meanwhile, the U.S. officially hit $20 trillion in debt, with about half of that added over the past decade or so.

The 2007-09 recession, brought on by the collapse of the U.S. housing bubble, is at least partly to blame, with the government responding with huge bank bailouts and the stimulus programs. In fiscal years 2009-2012, deficits exceeded $1 trillion.

James Rickards, attorney and finance commentator, in the Daily Reckoning blog said the current level of inflation, running below the Fed’s 2% annual target, is partially tied to the increase in the deficit.

“Now, the Fed printed about $4 trillion over the past several years and we barely have any inflation at all. But most of the new money was given by the Fed to the banks, who turned around and parked it on deposit at the Fed to gain interest. The money never made it out into the economy, where it would produce inflation. The bottom line is that not even money printing has worked to get inflation moving,” Rickards wrote.

On Wednesday, the market will see what the Fed has to say about the state of inflation in the world.

Beyond the Fed, the Bank of Japan is slated to deliver its updated policy statement on Thursday.

Article originally published by Mark DeCambre at