Even The Fed Doesn't Know Where The Economy Is Going

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Includes: DIA, IWM, QQQ, SPY
by: Nikhil Gupta

Summary

US Fed Chair Janet Yellen gives no clear signals about the US economy.

Strengthening US dollar and plunging oil prices hampering the economic recovery.

World markets may drop amid lack of positive triggers.

In her testimony on Feb 10, 2016, Chair of the Federal Reserve of United States Janet Yellen disappointed the markets once again. Dow Jones erased gains of more than 1% and ended the session 99 points lower at 15,915. Asian markets are trading on steep losses of 2-3 percent, and European markets have opened on a terrified note. I believe there is room for at least another 5% cut in US stocks.

In her testimony, Fed Chair ruled out an immediate switch to negative interest rates to boost the flagging economy, saying that more investigation needs to be conducted. Recently, Bank of Japan adopted negative interest rates to battle the persistent slowdown that has engulfed the economy for more than two decades now.

Janet Yellen on Current Economy and Inflation

The US economy is facing dual blows from a strengthening dollar and falling crude oil prices. Investors are rushing towards safe-haven assets such as US dollar and gold as risks of a recession loom over the world economy. A strengthening dollar is restraining the United Nations' exports, hampering the recovery process. Endless mayhem in the oil prices is also leading to cheaper imports and pulling down domestic inflation, which is keeping the inflation well below the long-term, desired inflation level of 2 percent. The latest inflation rate for the United States is 0.7 percent.

On current economic scenario and inflation, Janet said,

"Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar. These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market, although declines in longer-term interest rates and oil prices provide some offset."

Investors needed a more concrete view than was offered to them. As fears of slowdown grow with every passing day, Wall Street required the central bank to adopt a firmer stance to keep the economy from being dragged down due to global pressures. Blaming the crashing oil prices and the slowdown in China will not help investors' dwindling faith, and may even force them to pull out their funds, further crippling the economy.

On Monetary Policy

That the US Fed is unclear about where the economy is headed was further substantiated when Janet refrained from giving a proper outlook. She said,

"In particular, stronger growth or a more rapid increase in inflation than the Committee currently anticipates would suggest that the neutral federal funds rate was rising more quickly than expected, making it appropriate to raise the federal funds rate more quickly as well. Conversely, if the economy were to disappoint, a lower path of the federal funds rate would be appropriate."

Does this help? I don't think so. The market was earlier expecting at least 3 rate hikes in 2016, but recent speculations about the Fed turning to negative interest rates had taken centerstage. For now, even one rate hike for 2016 seems unlikey.

Your Takeaway

Indecision on the part of the world's biggest central bank will not go down well with the markets which are inches away from a full-blown bear market. This will only lead to a flight-of-capital from risky assets such as equities and real estate to safer options such as gold and US dollar. And nobody has a clue as to when this will end. But how will it end is an easier question to answer - badly!

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.