Daily State Of The Markets: Expectations For The Fed's Next Move

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by: David Moenning

The algos, or rather the math geeks that program the algos for the likes of Getco, Goldman, Citadel, Renaissance, and a handful of other banks/hedge funds/HFT outfits that can trade at the speed of light, appear to be a bit confused at the moment. On Thursday the S&P 500 plunged 1.32 percent on no news and then on Friday, it spiked up 1.34 percent on, oh, that's right, no news.

The bears attempted to argue that Thursday's dance to the downside was caused by Twitter's IPO (NYSE:TWTR). The thinking was that the 73 percent rise in TWTR on its first day of trading, when coupled with the bubbly action seen recently in many of the mo-mo darlings, marked the top in the current bull run. While almost no one saw the bubbles in technology and real estate in 2000 and 2008, apparently everybody sees one this time around.

The bulls countered on Friday by suggesting that the much-anticipated Nonfarm Payroll report, which showed that the economy created nearly twice as many jobs as Wall Street's PhD economists had projected, was a positive. The glass-is-half-full argument purports that the economy is "doing just fine, thank you" and that the outlook for growth is improving.

Anybody Else Confused?

But wait, doesn't the better-than-expected jobs report also mean that the Fed is more likely to taper in the near term? And isn't the stock market all about the "liquidity trade" right now? So, shouldn't the stock market have gone down Friday and not up?

Trying to identify the drivers of the market action can definitely be challenging at times. One minute the game is all about earnings, the next it's about the Fed, and then there are times when the drivers are not obvious at all. Are we having fun yet?

As a quick side note, if you want a deeper understanding of the way Wall Street REALLY works, be sure to check out Marije Meerman's The Wall Street Code. If you are not intimately familiar with the plumbing of the exchanges, be prepared to be amazed - and infuriated!

All About The Taper?

One could easily argue that the sideways trading action seen over the past two weeks has been tied to renewed concerns about when the Fed will begin to taper its current bond-buying stimulus program (aka QEIII). Recall that in the summer, stocks pulled back whenever it looked like the Fed may have had the evidence it needed to start stepping back a bit from the $85 billion in monthly bond purchases.

The current consensus among Wall Street economists is that the Fed won't begin tapering QEIII until next year. According to a WSJ poll, the group is split as to whether the FOMC will start cutting back on its bond purchases in January or March, with most leaning toward March.

However, any data that comes in stronger than expected - especially data relating to unemployment - puts that assumption in doubt.

The Way The Game is Played

The thinking here is simple. When the Fed starts to taper it means that there will be less bond buyers each month. Simply put, less bond buying by the Fed means higher interest rates. Higher interest rates means a stronger dollar. And the combo of rising rates and a stronger dollar puts a serious crimp in all those highly leveraged dollar-carry/bond strategies the masters of the universe continue to run.

This combo causes the hedgies to sell bonds, which, in turn, causes rates to spike (because no one is going to buy bonds when rates are spiking these days - no one!). Finally, spiking rates causes algos to sell stocks. Boom, stocks correct.

It's Clear as Day on the Charts

As can be seen on the chart below, the market has spent the vast majority of 2013 moving in one direction or the other. In other words, periods of uncertainty in which stocks have moved sideways for a while have been few and far between.

S&P 500 Daily - 2013

Click to enlarge
(Click to enlarge)

When one places the drivers of each move on a chart, it becomes fairly clear what the trends have been all about. And it is a decent bet that the current sideways move is about the question of the Fed tapering sooner rather than later.

Will The Fed Taper in December?

So... the Jobs Report was much better than expected. As such, the thinking is that the Fed could possibly begin tapering in December, right? Right. Some Fed governors actually stated as much publicly last week, calling the decision a close call.

Why aren't stocks tanking, you ask?

Not a Chance

In short, stocks aren't tanking at the present time because the last thing in the world the Fed needs is for the rates to spike and stocks to take a big 'ol dive the week before Christmas. The bottom line is that the boys and girls in Washington D.C. are doing a fine job shooting the economy in the foot. As such, the last thing the economy needs is for the Fed to do the same.

You see, if the FOMC did decide to play Scrooge during one of the biggest shopping weeks of the year, stocks would nosedive. And in turn, consumers would become dazed and confused... meaning that they would likely pull in the horns on their spending plans. And just like that, economic growth becomes a problem again.

Remember, the timing of the taper isn't really critical from a big-picture standpoint. And after spending the last four years using an "err on the side of caution" approach to monetary policy, it is unlikely that the FOMC will suddenly and without warning, change their tune. And the algos know it.

Turning to This Morning...

Both Asian and European markets sport improved results this morning, which is helping to buoy U.S. futures on this Veterans Day. There are no economic releases scheduled for the day and as a reminder, the bond markets are closed for the banking holiday.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell...

Major Foreign Markets:

- Japan: +1.30%

- Hong Kong: +1.43%

- Shanghai: +0.14%

- London: +0.31%

- Germany: +0.27%

- France: +0.46%

- Italy: +0.45%

- Spain: +0.62%

Crude Oil Futures: -$0.32 to $94.28

Gold: -$0.90 to $1283.70

Dollar: lower against the yen and euro, higher vs. pound.

10-Year Bond Yield: Currently trading at - closed

Stock Futures Ahead of Open in U.S. (relative to fair value):

- S&P 500: +1.34

- Dow Jones Industrial Average: +5

- NASDAQ Composite: +0.56

Thought For The Day ...

For a man to conquer himself is the first & noblest of all victories -Plato

Positions in stocks mentioned: none