Can The Fed Take An Action?

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Includes: DIA, IWM, QQQ, SPY
by: Ron Honig

Summary

The Fed's January conference is about the conclude today.

With current environment it is hard to believe that any action would be taken.

Here are the reasons why.

Those who followed Apple Inc. (AAPL) Earning call yesterday could hear Tim Cook's, Apple's CEO, frustration from the strong dollar.

As 66% of the company's revenue is Ex-U.S, the currencies exchange rate have taken a much more significant role of translating sales growth into financial success. As Cook said in the call: "$100 of Apple's non-U.S. dollar revenue in Q4 of 2014 translated to only $85 last quarter due to the weakening currencies in our international markets". This is a major hurdle to surpass in order to maintain sufficient growth in the top line.

If it is painful to Apple I would suspect that it would be even worse to the smaller in size U.S companies that have a high global presence. Sectors which have dual exposure to both currencies and commodities would suffer the most. And it can be a very risky turbulence to the economy if it financials continue to bleed.

What can the Fed do?

The Fed is facing a real dilemma. From one hand it can ignore the noises and follow through with its declared plan to hike rates. An alternative action is to turn the Interest rate wheel backwards and go back to the 0-0.25% rate levels.

The first alternative has a devastating risk to corporate America. If any, it would be the catalyst to later on choose the second path with severe consequences.

By putting more pressure of the currencies and getting the dollar to an even stronger position the great achievement the U.S. economy achieved in term of unemployment could take an ugly turn.

The next graph is taken from the Bureau of Labor Statistics. It illustrates the decline in U.S. unemployment throughout the recent six years. If a massive headwind in the shape of an even stronger dollar would hit the face of the U.S. corporations this would have a significant negative impact to the levels of employment.

The companies could have surpassed the barrier of a stronger dollar only in an event of a strong tailwind in global demand. The fact is that the majority of the world is straggling in that front in both job creation, demand creation and a sustainable growth. Without a growth in worldwide consumer demand there is a high risk for U.S. companies to deliver growth this year.

The strong dollar has a direct impact on the prices of commodities. Most commodities contracts are being settled in U.S. dollar and as the value of the dollar goes up that immediate impacts the value of the underlying commodity.

The next chart, taken from Nasdaq.com, illustrates the trend in crude oil price in the last eighteen months. Can the U.S. energy sector live with additional decline in oil prices before it would need to take a severe action on its investment?

And it is not only oil. Every commodity that is quoted in dollars will continue to fall in price inverse to a strengthen U.S. currency. It cannot be a beneficial path for the U.S. economy.

It will not be beneficial for the second indicator that the Fed closely monitors. Alongside the employment rate the Fed monitors the inflation expectations. With the strong dollar that alongside other geopolitical interests the commodities' prices continue to push downwards and by that any expectation for a significant inflation is being vanished.

It means that the two concrete indicators that the Fed announced it would pursue for a long term sustainable trend are in jeopardy.

A maximum U.S. employment level and at least two percent yearly inflation rate cannot coexist with a straggling local industries and a soft worldwide demand.

My conclusion is pretty straight forward. The Fed cannot allow four hikes this year. If any it would need to wait to see if any recovery in prices would take place in the second half of 2016 and only then reassess. The first interest rate hike that took place in December 2015 can be reversed only if a collateral catastrophic event would appear. I doubt we will get there.

In the meanwhile there are sectors that are subject to benefit from the low interest rates. REIT is one. Utilities is another. As markets continue to swings a long term investor should take advantage of the occasion drops in these sectors and take action.

As always I appreciate your inputs and comments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The opinions of the author are not recommendations to either buy or sell any security. Please do your own research prior to making any investment decision.