FOMC Statement – The One Word that Matters Most

By David Nelson, CFA

This week’s FOMC meeting is expected to be a yawner. It’s the middle of summer, it’s hot and half of Wall Street is on vacation. Like it or not Yellen and team will issue a statement that most believe will contain few fireworks. Below are some comments I came across this weekend.

Goldman: We expect very little change to the FOMC statement following next week’s meeting. 

Merrill Lynch: Fear of further “false dawns” will likely keep policy accommodative. 

Deutsche Bank: The Fed will want to see clear evidence of firming wage inflation before becoming more comfortable that the labor market is approaching their target for full employment. 

Like many I’ve become numb to FOMC statements. I generally comb through every word of the release looking for changes in policy or a hint that policy change is coming. Why bother? Some phrases have been there so long we take them for granted. They’re as boring as the disclosure at the bottom of my emails, Past performance is no guarantee of future returns.

One Word

The word considerable has been analyzed by half the economists on the planet. The phrase “considerable period of time” sits at the center of Fed Policy and has acted as an anchor for investor sentiment. In a recent note Morgan Stanley’s economic team wrote, The last time the Committee removed the word “considerable” from its statement, it increased interest rates six months later.

They point out under Greenspan, the August 2003 statement read “…policy accommodation can be maintained for a considerable period.”  In December the phrase was replaced with, “….patient in removing its policy accommodation.” By May 2004 the word “patient” was dropped altogether followed by a 25 basis point hike just one month later.

Chair Yellen gave us some guidance on just what considerable means to her. “This is the kind of term that’s hard to define but probably means something on the order of around six months or that type of thing, but what the statement is saying is that it depends what conditions are like.”

The current assumption is that the Fed won’t be looking to a hike until at least 6 months after asset purchases end in October. Many economists are pointing to much later in 2015 and some as far out as 2016.

Any change to the phrase “considerable period of time” will catch investors off guard. There would be an immediate re-pricing of the front end of the curve and a likely knee jerk reaction lower in stocks.

Are the Markets Seeing a Something Analysts Don’t?

Some of the data released last week exhibited Risk-Off behavior. Below is a graph from Merrill Lynch showing fund flows for High Yield. You have to love the term High Yield. Definitely created by the marketing department of some sell side shop decades earlier. When I first started in the industry they were called Junk Bonds for a reason. Spreads between Junk and Treasuries are extremely tight. Is this the first signs of an exit or just a false alarm like many of the others?

High Yield Fund Flows (Source Merrill Lynch)

Let’s turn to the currency markets. Surprising many is the recent strength in the US Dollar. Is the rise in the dollar another hint that either Fed policy may change or just the reciprocal action to a weak Euro? The dollar has certainly been strong but needs to break out further to make a convincing argument.

US Dollar Index – Cash Settle Weekly Chart

Mixed Messages

It’s hard enough for investors to make sense of the market without having to listen to Wall Street analysts and talking heads flip flop from week to week. Hey, I’m not leaving myself out of the criticism. We’re all guilty as charged. The desire to be right every day believing we can explain in detail what’s going to happen in the next 24 hours drives the rhetoric. The truth is we can’t be right all the time. Extending your time horizon to something more than the closing bell we’ll probably give better results.

I bring this up because in Goldman’s note Friday you read the following.

Equities: We downgrade to neutral over 3 months as a sell-off in bonds could lead to a temporary sell-off in equities. 

On its face it looks like just another comment from a Sell Side firm but put in context it speaks volumes to the frustration investors have with Wall Street. The note comes less than 2 weeks after this article appeared in the Wall Street Journal. Goldman Goes From Bear to Bull on U.S. Stocks

Fed Hike?

In an on air interview with CNBC’s Bill Griffeth earlier this year I said; “if we aren’t seeing higher rates by sometime in 2015 at least by mid-year, I may have to rethink my calculus.” I still stand by that statement.

Bears of course believe that the only thing driving equity pricing is an accommodative Fed policy. I think we’ll find that the bull market doesn’t have to end just because the Fed taps on the breaks. If rates are going up because the employment picture is turning more positive then bring it on.