Weight Of The World (Cup) On The FOMC

“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” – John Templeton

We are between stage 3 and 4 ? My mind hazy from all the late nights or rather, mornings I have been keeping, watching some of the soccer World Cup matches.

June 17 (Bloomberg) — The Federal Reserve will probably raise its benchmark interest rate faster than money-market investors expect, according to more than half of 56 economists in a Bloomberg News survey. Money-market rates show a 47 percent probability that the federal funds rate will be 0.75 percent or lower at the end of 2015. The median estimate of Fed officials’ forecasts in March showed  the rate at 1 percent at the end of next year. Economists expect that to stay the same at the June 17-18 meeting. A majority of economists also said that the central bank will end its asset-purchase program, known as quantitative easing, at its October  meeting. Following are the results of the most recent survey, conducted June 12-16.

Markets are gripped in paralysis mode and the DXY USD Index is up 1.38% since the last FOMC on 1 May.

It’s been 6 weeks and 10Y US treasuries are yielding just 0.03% higher at 2.65% today from the last round as credit spreads ground to their tighest since 2007.

In contrast, the best performing since the last FOMC has been the S&P 500 index which is up 3%.

Since then, geopolitical risks and tensions have mounted and oil price (WTI Crude) is up 7%.

The Fed’s worse fears have come true because these are some of the risks they had identified last month in the FOMC minutes.

1. Geopolitical risks
2. Possible top in the housing recovery
3. Concerns on increasing risk taking and excessive leverage in the financial markets
4. Poor labour markets – low participation rate, underemployment and slack

Markets, well aware of these risks, are also playing a game of dare with the Fed because the fact is that Yellen would not want to attract any form of negative criticism and lose the faith in her first 6 months of office, more so now that her former mentor and former governor at the Bank of Israel, Stanley Fischer, just got his confirmation as the Fed’s vice chairperson 5 days ago.

And markets are more than aware that Stanley Fischer is a well known dove, a term we have not considered in several months, along with hawks. The Federal Reserve has been consistently UNITED in the past months on the Tapering.

Alan Binder, a former Fed vice chairperson,  wrote an under-publicised piece in the WSJ last month, for markets to expect a rocky road ahead as the end of Tapering approaches and to expect the hawks and doves in the interest rate camps to create market volatility going forward. He expects the divide to show in the committee cum next FOMC, end July.  http://online.wsj.com/news/articles/SB10001424052702304536104579560252716882612

With the market so heavily positioned for a benign outcome, there are many first mover advantages and short term trades available for investors right now.

1. expect higher interest rates as a long term trend because the US economy is recovering strongly
2. credit spreads to widen out especially for junk bonds with 2-3 year maturity because they will have difficulty refinancing then. I also expect the Fed to voice concerns over the credit bubble
3. USD strength is an inevitable outcome of geopolitical risk and eventual monetary policy tightening

My trades for today will be to Sell the 10Y UST futures (at 124) for a short term trade, buy the DXY to target this year’s high of 81.30 and sell Aug calls on the Russell 2000 index.

We all need a little push when we come to crossroads or inflection points like we are at now. And since this is the first FOMC I will be awake for in a long time, thanks to the World Cup (just before the Spain v Chile match), it does feel like a huge weight is upon it too.