Fed Running Out of Time

Like a ray of light piercing the fog, last week Federal Reserve Chairperson Janet Yellen sent out a clear signal to the market regarding the its near term plan on interest rates.

At the committee’s annual policy symposium in Jackson Hole, Yellen said, “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.”

Yellen’s statement is as close to a promise as we can get from the Fed. And while her comments may not appear disquieting to some, the correlation between increasing interest rates and choppy markets can’t be ignored. After seven long years of near zero interest rates, the Fed raised the Fed funds rate to one quarter of a point last December and the market wilted.

That small shift upward had little impact for borrowers or lenders, but helped send the market into a tailspin. By mid February the S&P 500 had dropped 10% and investors were starting to sweat. Although the market has recovered all of that drop plus more, conviction that the Fed is marching along a consistent path of rate increases may cause more market turbulence.

With market averages at all-time highs and valuations stretched I’ve been installing bumpers on the portfolios of Profit Catalyst Alert and Growth Stock Strategist to cushion the blow of any drop. Just this week I issued another put purchase recommendation in Profit Catalyst Alert. In Growth Stock Strategist I’ve issued stop loss and buy limits on all stocks to help insulate gains.

Clearing the Fog

The Fed has not always been so forthright with its intentions. In fact, in the 1970’s the prevalent belief was that the Fed should be as vague as possible about its plan for interest rates. It was not until 1994 that the Fed publicly disclosed changes in its target for the federal funds rate. Five years later in 1999 the Fed added a future looking statement similar to the one Janet Yellen put out last week.

Back then investors yearned for scraps of data regarding the direction of interest rates. They would monitor the trading desk at the Federal Reserve Bank of New York for clues about the Fed’s purchase or sale of bonds, which would indicate its desire for higher or lower rates. Later in the 1980’s, huge market swings would occur on days that levels of certain money supply levels were reported, another harbinger of Fed action.

Thanks to sweeping changes that lift the veil of Fed secrecy, investors need not connect hazy dots to determine the direction of interest rates. Yet most Fed chair people offer somewhat opaque commentary to give the board wiggle room when deciding what to do with rates. Yellen’s recent statement is one of the most direct statements we’ve heard.

Big Friday

Friday’s report on job gains is a critical component in the Fed’s final decision. The Fed’s analysis of economic health has been weighted toward growth in employment. Job gains, which have averaged 190,000 for the past three months, indicate corporate confidence in future growth and foreshadow strong consumer spending. The jobs report due out this Friday will likely determine the fate of rates this year.

Although there are three Fed meetings scheduled for the balance of the year, the one on September 20 to 21 is the most likely time for a rate change. The November meeting is dangerously close to the Presidential election and the final meeting of the year scheduled for mid-December may be waterlogged by post-election turmoil.