Shocking, another day where the Fed moved the market with important short-term commentary that will likely be irrelevant longer term. Tuesday morning, in the always humorous congressional oversight hearings of the Fed, Federal Reserve officials hinted that rates could go up sooner than some may think. Their target date for a possible interest rate raise: 2014.
While, obviously, as the economic data has been steadily but still only moderately improving over the last six months the prospect of a rate increase has been increasingly likely, I think the Fed is highly unlikely to take any imminent action for several main reasons.
First, the primary reason the Fed has continually engaged in QE1, QE2, and other monetary stimulus efforts, is to push inflation. Obviously, it is easier to cause inflation than it is to create growth. Unfortunately, despite the Fed's best efforts, banks have been unwilling to lend significantly to consumers and small business.
Therefore, the Fed has really only been able to cause inflation through devaluation of the dollar. To me this is the key to understanding the Fed's current policy. Devaluation of a currency is essentially a sophisticated way of defaulting on our debt. The devalued dollar causes dollar denominated commodities to rise, it gives our exports an advantage and helps create what the Fed has nicely termed the "wealth effect" - Americans who feel like they have more money since their portfolios have gone up.
The main reason I think the Fed would not even realistically think of raising rates in this environment is that nearly 60% of the dollar's value is tied to how it trades against the euro. If the Fed were to tighten while the ECB is engaging in multiple rate cuts and other liquidity pushes, the dollar could rise dramatically.
While a rising dollar might lower inflation expectations, a significant rise in the dollar would also likely lower stock prices and hurt many of America's strongest companies. Clearly not what the Fed wants.
The S&P 500 (SPY) Tuesday has few multinational companies getting most of their revenue from the U.S., and the Nasdaq's leaders likes Intel (INTC), Microsoft (MSF), IBM and Apple (AAPL), are also highly leveraged overseas. Intel gets nearly 70% of their revenues from international sources.
So why would the Fed suddenly begin to talk about rate raises when Bernanke and Obama have clearly favored a weak dollar policy for some time? Call me cynical, but I have the feeling that Obama doesn't want to release the SPR in an election year for fear of being accused of politicizing the nation's reserves.
With oil and agricultural prices near the high end of their five year range, a bluff from Fed officials appears to be more bluffing the commodity markets than fundamentally altering the central bank's long-standing policy. While the post-election period may yield some important legislative accomplishments, in the near-term, Congress is unlikely to move on any important piece of legislation in an election year.
With election season about to ramp up and oil prices usually peaking in the summer, I am skeptical of the Fed's timing for this supposed change in policy. With the summer driving season right around the corner, Syria still in chaos, and issues with Iran far from resolved, a pullback in Brent (BNO) and WTI (USO) should create a nice entry for longs.