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The Fed can hold steady

Next week, all eyes will be on the Federal Reserve when a decision on interest rates comes Wednesday afternoon. For quite some time, there has been an expectation that at least a 25-point reduction will come, and more global stimulation has helped the US markets to approach all the time. However, the latest economic news has resulted in an interesting reaction to the bond market, one that makes me wonder if the Fed will stay steady and thus be struck by President Trump's anger.

US markets headed by the S&P 500 (SPY) gathered on Thursday after President Trump delayed some Chinese tariffs by a couple of weeks as a gesture of goodwill. That decision happened to follow a move by the Chinese government to exempt certain US products from customs duties. Further escalation in the trade war would limit the negative economic impact on the US economy, which would be a reason not to cut interest rates. Throw in stronger retail sales and consumer experience data, and the argument gets a little stronger.

Interestingly, we saw interesting inflation data this week. The producer price index, excluding food and energy, increased by 2.3% year-on-year, which was one-tenth of a percentage point ahead of expectations and a two-tenths increase from the previous month. We saw a similar story with the consumer price index of 2.4% versus estimates of 2.3% and 2.2% before reading. Warmer inflation than expected can cause the Fed to pause a bit as well.

On Thursday, the European Central Bank announced another round of quantitative easing. Although this would initially be a measure that was fully endorsed by the member states, there appeared to be a number of nations that did not approve it. Euro dropped on the first news and fell to a low EUR / USD of 1.0925 which was low, only to rise to a high of 1.1086 in the afternoon.

As the dollar / euro began to turn, we also saw an interesting move in the US bond market. Take a look at the 5-day chart for 30-year returns, which was down during the pre-market session but then rose more than 10 basis points from the daily low price. This continued the yield rally, with the long bond up about 40 points from its most recent low. As a result, we have seen a decline in iShares 20+ years Treasury Bond ETF (TLT) as bond prices fall as yields increase.

( Source: Yahoo! Finance)

As President Trump looks to be re-elected next fall, he hopes a strong economy will lead voters to give him another four years in his election. As a result, he demanded that the Federal Reserve cut interest rates again and again in the hope that almost zero-interest rate policy would strengthen the US economy. Interestingly, there are those who argue that by fighting China against trade, a weakening of the US economy in the short term will lead to more interest rate cuts when 2019 ends and into early 2020.

While US interest rates are close historical lows, they are still much higher than counterparts from other developed countries. As the chart below shows, the US 10-year, which has risen above 1.80% recently, is about 150 points above the average for six 10-year New Year loans. More and more countries have seen their prices go negative in recent months and further economic stimulus may continue this trend.

( Source: cnbc.com bond page, seen here)

What will happen next week if the Federal Reserve decides not to cut interest rates? Well, it is quite certain that President Trump will be very unhappy and fire a bunch of tweets. While the central bank can signal that the US economy is doing better than previously thought, along with inflation a little warm, the stock market would sell overall, thanks to the jumping off of additional housing. Entering the Fed meeting at all times in the heights can easily create a "buy rumors, sell the news" event even if the Fed does not lower, but if interest rate policy remains unchanged, it will likely be very red due to less easy money policy. What do you think the Fed will do next week? I look forward to your comments below.

Publication: I / we have no positions in any of the aforementioned stocks, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I don't get compensation for it (other than Seeking Alpha). I have no business relationship with any company whose shares are mentioned in this article.

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