High is a relative term. Let’s take a look at what is normal and the effects of artificially low interest rates ahead of the FOMC.
PRE-OPEN MARKET COMMENTS FED-DAY – The selling pressure has been heavy since August and Q3 earnings have not sparked buying in the last two weeks. Valuations are fairly stretched, but they have been that way most of the year. The economy is strong and higher interest rates have not knocked our legs out from under us. Traders were expecting growth to slow and they priced in a rate cut in Q4 on that notion. When that forecast was proven wrong, they scrambled to sell bonds and yields shot higher. That put additional selling pressure on the market.
The Fed is close to the end of its tightening cycle, but the threat of “higher for longer” is still weighing on the market. Today the Fed is likely to keep rates unchanged and there is a 70% likelihood (based on Fed Funds futures) that they will pause in December.
The market is addicted to “easy money” and it has been since the 2008-2009 financial crisis. We’ve gotten used to zero percent interest rate policies (ZIRP) so the current backdrop makes it feel like yields are sky high. On a historical basis (50 years), a 5% yield on a 10-year bond is normal. It is important for yields to be at this level even when we are not fighting inflation. It provides fixed income investors with a decent return on bonds and they are no longer forced into owning equities. This means that some money will finally flow out of equities and into bonds. From a corporate standpoint there are a few implications. The most obvious is that higher yields will increase borrowing costs. In the last decade, corporations issued debt at ridiculously low rates and they used the proceeds to buy back shares. In the last decade, almost 50% of the outstanding shares have been repurchased. That puts extreme upward pressure on stock prices. More money chasing fewer shares means the price goes up. Higher borrowing costs will also force corporations to be more cautious when they invest in plant and equipment. ZIRP breeds inefficiency and we are likely to see some corporate failures.
In the long run, this is all good for economic stability. In the short run, there will be some pain if interest rates stay at this level for another year.
When you take penicillin every time you get a sniffle, eventually it stops working. Unfortunately, that has been Fed policy for the last decade and artificially low interest rates and excessive money printing no longer had any “punch”. Central banks were painted into a corner and they no longer had any tools in the event that we had a crisis. I hope the Fed keeps rates at this level for a long time, but I doubt they will. There would be too much pain and at the first sign of an economic slowdown, they are likely to take their foot off of the brake and step on the gas.
I just thought I would provide you with some macroeconomic insights. They won’t impact our short-term trading, but it is often helpful to know what is driving the action.
I feel that shorts are going to continue to take gains into the FOMC and we should see an upward bias. This is a seasonally bullish period and any seasoned trader will be reluctant to short here. We are going to open higher and there is a slight chance for a gap and go. 1OP will start on a bullish cycle and we have seen some buying this week. Don’t chase. Wait for confirmation.
Support is at $417 and resistance is at the 200-day.