The Fed Is Gonna Getcha (In July Even)

| About: SPDR S&P (SPY)

Summary

In our last report, Mr. Potter is Buying Stocks Post Brexit, we indicated investors should start picking up equities.

This report is a warning that expectations for the Fed are misplaced, with the market assuming the Fed pause in June, partly due to the Brexit vote, holds moving forward.

I believe the Fed wished to minimize market volatility around the U.K. referendum, and now that is has passed, will be less concerned about diminishing economic ripples reaching our shores.

Fed funds futures indicate the market is convinced the Fed is off the table this year, and it even perceives a rate cut is possible.

However, if the June employment report is solid, as I expect it will be, I expect we will see Fed members talking up July and Fed action to raise rates.

Remember when the Fed didn't raise interest rates at its June meeting and stated the upcoming U.K. referendum was one of the reasons for its caution? Some of the people scrambling for cover on business television post Brexit were criticizing Fed Chair Yellen just weeks before for bowing to foreign pressures. Today, the Fed is like, "How do you like me now." But, now the pundits are proposing there is no shot of a Fed action this year. I think they'll be ducking for cover again soon.

The Fed wisely told us at its June meeting that May's monthly employment data for nonfarm payrolls was cause for caution. A depressing net increase in job creation of just 38K in May baffled most and even fell short of my low estimate for 84K (let's see what the revision shows). But the Fed said there was a chance the month's data could be a one-off, and that better data might relieve its concerns in June. That is certainly my view.

Still, some argued, including within the Fed, that lower job creation should be expected now that we're near or at full employment, though given many are still out of the workforce. Those folks vehemently argued for a rate hike, and looked to see if the Fed would let Brexit get in the way. The Fed followed through with caution and listed risk tied to uncertainty around the U.K. referendum as another reason for its caution.

In doing so, it's my view that the Fed sought to minimize financial market volatility, which we know can feed back into the economy. Such a result would have severely harmed Fed credibility, as it could then have been forced to almost immediately reverse its action, something it would prefer to avoid. As a result, I believe, of the measured action of the Fed, we had only a minimal disruption to our markets. But now many in the market are saying the Fed cannot touch interest rates in July or through the remainder of the year even, due to potential economic fallout from the divorce of Europe and the U.K.

In this regard, I think the market and pundits have mistaken the Fed. I expect the Fed understands that the yet undetermined economic ripples from overseas will decrease in severity by the time they reach our great shores. Also, any economic damage should take some time to result, and the Fed has a need to normalize monetary policy now while our economy here at home is solid.

What's important to the Fed is that the U.K. referendum is now history, along with its resulting volatility for financial markets. If the Fed, therefore, gets a good employment data point for June, then I believe it will raise interest rates in July. I do not care what the fed funds futures indicate the Fed will do today (they are now even giving a rate cut a chance). Those indications will change if a strong employment data point is reported for June, and as Fed members begin reminding investors that they have two mandates, employment and inflation, and not the European economy despite its global relevance.

The other issue is the dollar, because its strength becomes a problem when it gets excessive. It can depress the price of oil, and our energy sector is already stressed. It also limits the competitiveness of American multinationals overseas. But the dollar seems to have leveled off, and I'm not sure the market will attribute it too much more strength ahead of any Fed action in July given the certainty of the market today for Fed inaction. Also, I'm expecting to see some serious fiscal stimulus announced in Europe and maybe the U.K. soon, which would serve the euro versus the dollar.

Security Sector

06-28-16 PM

SPDR S&P 500 (NYSE: SPY)

+1.0%

SPDR Dow Jones (NYSE: DIA)

+0.8%

PowerShares QQQ (NASDAQ: QQQ)

+1.4%

iShares Russell 2000 (NYSE: IWM)

+1.3%

Vanguard Total Stock Market (NYSE: VTI)

+1.1%

Financial Select Sector SPDR (NYSE: XLF)

+1.5%

Technology Select Sector SPDR (NASDAQ: XLK)

+1.1%

Energy Select Sector SPDR (NYSE: XLE)

+1.8%

Health Care Select Sector SPDR (NYSE: XLV)

+1.3%

Consumer Discretionary Select Sector SPDR (NYSE: XLY)

+1.2%

Consumer Staples Select Sector SPDR (NYSE: XLP)

-0.1%

Utilities Select Sector SPDR (NYSE: XLU)

+0.1%

Materials Select Sector SPDR (NYSE: XLB)

-0.1%

Industrial Select Sector SPDR (NYSE: XLI)

+0.9%

iPath S&P 500 VIX ST Futures (NYSE: VXX)

-7.0%

Widely Held Stocks

Apple (NASDAQ: AAPL)

+0.7%

Microsoft (NASDAQ: MSFT)

+1.2%

General Electric (NYSE: GE)

+1.6%

Verizon (NYSE: VZ)

-0.3%

McDonald's (NYSE: MCD)

+1.6%

Facebook (NASDAQ: FB)

+2.6%

Ford (NYSE: F)

+1.3%

Citigroup (NYSE: C)

+3.2%

Exxon Mobil (NYSE: XOM)

+1.4%

Amazon.com (NASDAQ: AMZN)

+1.9%

Click to enlarge

While I think stocks can enjoy a bit of a run here (see Potter is Buying), given the prevailing market expectations for the Fed, I also expect an abrupt change in sentiment once the Fed moves in July. Watch out toward the end of the month because the Fed is gonna getcha. That's another bold call from your nonconformist friend who tells it to you like he sees it no matter how far off the consensus forecast it is or how crazy he looks until it happens. Please take note as always. For my regular work on the market, I welcome interested parties to follow my business column here at Seeking Alpha.

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.