The Trend

Markets Could Fall 15%, If This Is True

By all accounts, the Fed Reserve is ready to hike rates.

According to the CME Group, there’s now a 95.4% probability the central bank could raise rates by 50-75bps on December 14, 2016.

If true, the markets could sell-off just as ferociously as they did in January 2016.  At the time, the group was confident the economy was strong enough to handle higher borrowing costs.

But as they would soon learn, they were wrong.

Optimism was premature.  The economy wasn’t ready, as they had hoped.

World markets plunged, as a result.  The Dow Jones fell more than 2,100 points in weeks.  Trillions of dollars of value were wiped out. 

Sadly, it could all happen again.

Even with inflation stuck at 1.6%, coupled with poor business investment and soured consumer sentiment, the Fed is likely to raise rates anyway. 

In fact, according to Fed chairwoman, Janet Yellen, the Fed could at “relatively soon.”

All as government data points to a stronger economy with improving GDP, and a stronger labor market.  There’s just one problem with the data, though.  It’s not strong at all.

To begin, if the Fed moves to tighten the reins in a “growing economy,” businesses could struggle with higher borrowing costs, which could weigh on growth.

Two, the economy is not improving, as the Fed believes.

GDP growth for the last several quarters has been less than 1%.  Sure, third quarter GDP grew at a rate of 2.9%.  Unfortunately, the headline number doesn’t tell the whole story.  Personal consumption, for example, slowed to a rate of 2.1% from 4.3% in the second quarter.  It was also worse than estimates for 2.6%.  In addition, business spending on equipment fell 2.7% -- falling for the fourth consecutive year.

Worse, if we were to exclude the 10% jump in exports, helped by a temporary boom in the shipment of soybeans, a business inventory build of $12.6 billion and ObamaCare contributions, U.S. GDP only grew at a pace of 0.9%.

Three, the unemployment rate of 4.9% masks a labor market much weaker than reports suggest.  Nowadays, more than 94.7 million adult Americans are out of the workforce. 

If U.S. unemployment were really that low, inflation would be closer to the Fed’s healthy target rate of 2%.  Instead, the central bank’s preferred measure for inflation – the Personal Consumption Expenditures (PCE) – has been stuck around 1.6% since March 2016.

Still, members of the Fed believe we’re ready for a rate hike.

St. Louis Federal Reserve President James Bullard recently said, “Markets are currently putting in a high probability on a December move by the FOMC.  I’m leaning towards supporting that.”

Even Goldman Sachs sees a “75% chance of an increase [in December], roughly in line with market expectations,” they noted. “The remaining uncertainty relates to economic data and financial conditions, rather than uncertainty about the Fed’s reaction function—conditional on decent data and stable markets.”

Unfortunately, as we’re all well aware, another wrong move by the central bank could easily send the markets screaming lower.

Let’s hope the Fed thinks before it acts.  We can’t afford another 2,100-point drop.