The Business Times

Dow likely to stay flat till Fed rate meeting

Current rally could then resume, if central bank sends signal that many believe it will

Published Sun, Dec 6, 2015 · 09:50 PM

COULD the year of treading water end with a sprint?

US stocks finished higher last week as a strong jobs report and hints from Federal Reserve chair Janet Yellen that a rate hike was a fait accompli inspired one of the strongest rallies this year.

Between now and the Fed's meeting on Dec 16, US stocks are unlikely to move much further. The rally could then resume, if the central bank sends the signal that many believe it will. That signal: "We are raising rates, but only by the bare minimum."

"It's taken a while - about two-and-a-half years, but the market may have finally come around to the idea that the Fed will pursue the most dovish tightening of monetary policy in history," said Michael Arone, investment strategist for State Street Global Advisors intermediary business.

Another money manager says the Fed will sugarcoat the medicine of the rate hike with promises that its policy change will be gradual.

"The best gift the Fed can give us for the holidays is some certainty around rate policy," said Steve Chiavarone, portfolio manager at mutual fund firm Federated Investors. "All year they've been preparing us for a rate hike, and their rhetoric has been around that. But it's not a normal rate hike where they're trying to slow down an overheating economy ... they're trying to normalise."

Recently, the Fed's rhetoric has shifted.

Last week, Ms Yellen said the Fed must move cautiously because of the US dollar's strength - a danger to US exporters and commodities producers. The dollar sat at a 13-year high against most currencies and near parity with the euro until Thursday. That was the day the European Central Bank (ECB) was widely expected to switch seats with the Fed, adopting the easy money policies that the European authorities had resisted when Ben Bernanke first imposed them in the US But Mario Draghi, the president of the ECB, shocked the financial world when he disclosed the central bank's more modest stimulus plans.

Shares plunged worldwide as traders realised that there would be no substitute for the trillions of dollars the Fed has pumped into world markets. Strategists at Goldman Sachs, who had boldly predicted the imminent return of parity between the euro and the dollar because of the divergent policies, publicly disclosed that they had "badly misread" the ECB's intentions. The euro rose by the second-largest increment against the dollar in its history. A 4.5 per cent, five-cent leap from trough to peak was the kind of move that wipes out entire hedge funds. In currency markets, moves are usually measured in hundredths of a penny; for corporations shipping goods overseas, moves of this magnitude can result in billions of dollars of foreign exchange losses.

The euro pared its gains on Friday when Mr Draghi sought to reassure markets with promises that the bank would expand its stimulus programme further if warranted. For some US corporations, however, the dollar's weakness was likely welcome.

The strong November jobs report suggested that booming Internet, auto and home sales were compensating for pockets of weakness in manufacturing, exporting and energy sectors. The US consumer's appetite for spending borrowed money was the driver for the last US economic and stock market cycle. Chastened by the Great Recession, the consumer has taken a back seat in the current recovery. But record high car sales and "must-have" holiday items such as the foot-operated electronic skateboard known as the hoverboard indicate that the conspicuous consumption that once defined American culture may be on its way back.

It's become clear that a revolution in spending habits that began during the dotcom boom has now crested. For the first time, total online sales for the Thanksgiving weekend were higher than those in stores. That's before tallying results from Cyber Monday, a new tradition, which marks the start of the online shopping season. Gap, one of the kings of mall culture, reported a steep drop in its November same store sales, echoing warnings from Macy's, Nordstrom and others. The mall is dead; long live the virtual mall.

Friday's retail sales report could show further weakness in November, but economists caution against reading too much into a report that doesn't fully capture online shopping activity.

"(I don't know) if we're getting a holistic view of spending and things by just looking at pure bricks-and-mortar retail sales," said Mr Arone, of State Street Global Advisors.

Friday's retail sales count for November may not fully capture the holiday-shopping picture.

Consumers should have money in their bank accounts, with petrol prices at their lowest since the financial crisis.

In Vienna last week, the Organization of the Petroleum Exporting Countries (Opec) stuck to its guns, keeping the spigots of production running close to maximum capacity. Led by Saudi Arabia, Opec has kept this scorched earth policy going for more than a year. By driving prices down, the cartel is trying to shake out competitors in North America whose marginal cost of production is higher.

Analysts say shale producers in North Dakota and Texas will continue pumping oil until the price drops low enough to send them into bankruptcy.

It may not be a happy Christmas for all. Still, Mr Arone and others say, the net effect of lower oil prices on a consumer economy like that of the US should be positive.

The annual Santa Claus rally may yet be on its way.


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