Are you watching the Fed's actions with your eyes peeled? Sadly, I have been forced to do so. There was a time when fundamentals mattered. There was a time when stock picking was more important than macro musings. There was a time when correlations were lower between stocks and sectors. There was a time when Trump would have never thought of running for El Presidente. It was back when the Fed was a little less transparent, a little less talkative, and the economy hummed along and the markets did their work of valuing securities properly.
Alas those times are gone. The Fed is now all important. But has it gotten so important that nothing else matters? Of course not. But turn on CNBC or any news outlet, or open a publication and you would be unlikely to miss some commentary about the Fed. Heck, I am here commenting on Fed! The probability of a raise heading into the Sept. 21 meeting currently sits at 24%. The probability of a raise by the end of the year seems like a layup if you were to look at the current implied probabilities.
However, I think that the market has become way too fixated on the Fed and has missed the forest by looking too closely at the trees! Why, do you ask? Well, take a look at what LIBOR has done over the past month.
It has conveniently moved up from ~60 bps to ~86 bps. Now many readers here may not be truly aware of the powerful nature of LIBOR. Let me quickly explain what you are looking at. LIBOR is the rate at which banks lend to each other. It tends to track very closely with the short-term rate that the Fed controls plus a few basis points because everyone has to make a little extra coin after all. As you may have noted already, it is not the Fed that ultimately decides who gets to borrow money, it is the banks. The banks originate the loans and the mortgages and all sorts of paper wonderful and toxic alike. They also lend to each other in order to facilitate business. The LIBOR is what forms the interest which the banks pay each other in order to facilitate transactions.
It is very important to the functioning of the overall market, of course, because all the companies on the S&P 500 (NYSEARCA:SPY), the Nasdaq (NASDAQ:QQQ) and the Russell 200 (NYSEARCA:IWM), all the way down to the tiny little Mom and Pop shop, have a bank. If there are ever issues which come up in form of a liquidity challenging event, banks stop lending to each other, and what we would get would be the second coming of 2008-2009 type crisis.
However, it appears that liquidity at this point in time is fine. What is highly apparent is that LIBOR has moved in front of the Fed. Now the natural question is "Why?"
As you may recall, there were several new regulations which came into effect as a result of the huge crisis we faced in 2008-2009. The regulators definitely don't want to have this re-occur again. Money market funds, which are the closest thing to a prime, high liquidity, safe and sound investment had actually come under pressure during the crisis. The new measures will require these funds to temporarily bar redemptions (bad) and also allow the value of the funds to float (it has usually been fixed at $1/unit). There is almost $2.8 trillion invested in these short-term funds and the investors have decided to pull their money from these funds as a result. The anticipated withdrawals are expected to range from $200-400 billion. These withdrawals have resulted in a spike in LIBOR, but because of the changes, the spike in LIBOR will likely not resolve to its previous levels of 60bps. What this all means is the market participants have already increased the funding rate for each other without the Fed needing to.
Changes in LIBOR rate will affect virtually all companies that do business internationally in some way, shape, or form. Companies which will be impacted more than others include Valeant (NYSE:VRX), whose pile of debt is largely pegged to LIBOR.
Now switching gears, I am very lucky to know some very smart people. And some of the smartest people I know are not even looking at the Fed, because whether or not they decide to raise doesn't have a huge impact on the way business is conducted because as I just laid out above, business is largely conducted using the LIBOR rate, which has already moved higher. The really smart people are paying attention to the BoJ and their policy making. It is not about whether or not the BoJ moves the front end of the rate up or down, but how it is going to change the long end of the yield curve. The Japanese have been buying the long end of the yield curve, which has flattened the rates and made business very very difficult for the banks. The BoJ gets this (I think), and as a result, will likely try to stimulate the long end of the yield curve higher. This impact could have some major reverberations through the currency, bond and equity markets all across the world. In fact, some of the changes are already getting priced in as the USD-JPY basis swaps and USD-EUR basis swaps have moved mightily recently and those moves have been attributed to the change in the bond curves both in the US, Europe and Japan. It is for this reason the smartest minds I know are closely watching Kuroda over Yellen. As for myself, I can't wait for things to go back to normal to a place where Econ 101 still applies.
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.