Is the market concluding the Fed "put" is coming back ?

 

The minutes of the December Federal Reserve interest rate meeting delivered a dovish tone. This would suggest the Federal Reserve may becoming more cautious, post the last quarter market volatility, to increasing interest rates further. Indeed, the minutes referred to the possible impact the recent market volatility could have in confidence in the broader economy. Equity market investors were often comforted, as the global economy recovered from 2008, that the Federal Reserve would provide underlying support for asset prices, using monetary policy. The term used by traders was the “Fed put “, describing a financial instrument that can be used to protect the investor's downside in times of uncertainty. This ”put “had slowly been removed as the global economic recovery took hold.

Post the release of the December meeting and recent comments from Jerome Powell the current rally could suggest investors are hopeful the Fed is prepared to provide something of a put once again. This is despite their overall public commitment to price stability, and the market moves must not influence their interest rate decisions. At the same time as turning a tad dovish the Federal Reserve members were keen to stress, they feel confident in the underlying strength of the US economy overall.

It is, looking back now, not entirely by surprise equity markets have recovered from the big pre-Christmas selloff. Sentiment indicators, for example, the CNN fear and greed index fell deeply into fear territory. Valuations for US equities, assuming earnings expectations are met, fell below historical averages having spent the last couple of years above them. The US yield curve had steepened modestly or at least had not inverted any further. China is once again introducing measures to ensure their economy meets growth expectations, after a period of weak data.

The other measure we look measure fear and greed is the Vix index, considered useful as it prices in the cost of insuring your portfolio against market falls. For the extended period of low volatility equity investors have enjoyed, fear was measured as the index traded above 20. Having risen above 20 in early November and remained there for the past two months, it closed Thursday night just below that psychological level.

The big test for equity investors will come on Monday as the fourth quarter earnings season, for US companies begins. Apple warned of lower revenues for the coming year a few days ago, and this led initially to a broader fall in equity markets, however, encouragingly, equity markets quickly recovered their composure. American Airlines on Thursday cut its guidance for the year ahead. Expectations have been lowered for the coming season, how companies deliver against those expectations will undoubtedly influence sentiment for the coming quarter.

 

Posted on January 10, 2019 .