On Friday the 6th, we saw a big drop in the market after a strong employment report. This was due to fears that the Fed was going to raise interest rate because of the report. Good news was interpreted as bad, hence the sell-off.
The reaction of market was actually good news for the Fed because it now knows that investors are not ready for a rate hike. Now the Fed has to manage fickle humans not the economy. It is time AGAIN for the Fed to play the psychology game from the gift it has been given. This is a very easy task for the Fed to deal with because that is exactly what they did to end QE without market drama. I heard a lot about how they can't taper QE. Then I heard a lot about how they will stop the taper. Many even said they will stop the taper and increase QE. Now I'm hearing that the Fed cannot raise rate without causing an economic collapse. The Fed is in the process of doing just that. But first it has to give investors a dose of psychology as it did in ending QE. The Fed can raise rate anytime it wants, but it will do so only after it takes care of the fickleness of investors. When it is almost time to raise it, they will be talking about 25 or 50 basis points increase with the intention of raising it by 25bps. Then fickle investors will be happy it is 25 not 50bps increase. That will result if a big rise on that day. They will do the same when they want to raise it to 50bps (by talking about 50, 75 or 100).
The Fed is in no hurry to raise rate for the following reasons (that I can think of):
1) Inflation is well below the Fed's target of 2%.
2) Central banks around the globe have been slashing rates.
3) There is good growth but it is not robust to worry about overheating at this time.
4) Wages have been stagnant.
5) Raising rate will further strengthen the dollar which is already at a 12 to 13 year high. That will further expand the trade deficit as it will greatly affect export especially given that most economies are struggling. Folks will stay away from US products. So US will have to consume its products. It means companies will have to slash their earnings even more than it is happening now due to slow international demand because of the the high dollar.
It means the Fed has so much time to take things easy. So they will keep talking about rates but not do anything about it so that our foolish minds can hear it so much that we ignore it. The Fed will go back and forth about raising (hawkish) and not raising (dovish) until we are saturated.
So look for the chairwoman to be dovish in Wednesday's FOMC announcement. They can say whatever they want, but the fact is that it has little or nothing to do with the economy as they claim. It is all about managing our mental disorder with psychology not medication. Even if Dr. Yellen comes and stays something that is misconstrued as being hawkish, they will fix that on Thursday and Friday by saying what they "really meant". There are three Fed speakers on the economic calendar for Thursday and Friday. They will likely send another to CNBC if needed. It is not that they don't want the market to go down, they just don't want fear to feed on fear because it can quickly become a domino effect and lead to a global crisis. So they will do everything to eliminate fear. It is okay to have a bear market that is steady (as this bull market has been) than those flash crashes. Folks just can't handle it. They will become irrational in their decision making because of fear.
I believe we will see dovish FOMC announcement which will result in a sharp rise mainly because of what happened on the 6th. It will compensate for it (and more) because it will eliminate the emotional reaction and continue its previous trend (up).
