The Fed Narrative and “The Upside Down” Market, by D. R. Barton, Jr.

Barton TT1The Netflix show Stranger Things has been all the talk in the entertainment world. Despite Netflix’s stock drop after earnings last week, the show has been a cornerstone in content offering from the company and received a record 40.7 million unique user views in Season 3’s opening weekend over the Fourth of July holiday.

The story features a group of middle schoolers/ high schoolers who in their own various ways, experience a parallel dimension called “The Upside Down.” The Upside Down world mirrors in many ways what happens in the “normal” world but with distinct differences. There are monsters, superhuman powers, governmental conspiracies, and other intrigue that fuels the story line connecting our world and the parallel world. In some significant ways, the current stock market is in its own “Upside Down” mode.

Market Reactions – Mirrored

Just like the parallel dimension in Stranger Things, markets react very differently (opposite even) when the dominant narrative is the question: What will The Fed do?

As an example from ten days ago, the U.S. futures market opened on Sunday evening and started trading down. Nothing drastic, mind you, just some selling as traders took profits after the strong run-up at the end of the previous week. Then an economic report came out from China announcing its lowest growth rate in three decades –

952 DR chart1
That’s bad news from the world’s second biggest economy, right? That should have accelerated the selling on that Sunday night, right? Well . . . look at how things actually unfolded on the ES 30 minute bar chart below. Despite the bad economic news driven by tariff-induced slow-downs, the market traded… up.

952 DR chart2

In this current environment, bad news is good for the market. In case that connection isn’t clicking in your head yet, the rationale goes something like this:

1. When the Fed (and other central banks) are “accommodative” or pursue monetary policies that support faster economic growth, that influence overshadows most other traditional market drivers. We watched this during the 2009 – 2017 run up in the markets. Central banks can facilitate economic growth in various ways including:

  • Lowering interest rates (this makes financing cheaper for new business investment — or for companies to buy back their shares with borrowed money),
  • Lowering reserve requirements for banks (this means banks have to keep less money on reserve and can theoretically loan more money for businesses to grow),
  • Other stimulus dubbed “quantitative easing” (such as buying the government’s Treasury Bonds).

2. Because this monetary stimulus has such a strong effect on stock markets, factors that might make the Fed provide additional stimulus make the market go up.

3. What would make the Fed do these things? Signs of a slowing economy — poor economic data.

4. So when we get bad news, the markets react positively. And when we get good economic news, the markets drop.

5. In short — good news is bad for markets and bad news is good . . . The Upside Down.

A News Driven Week

Understanding that, I will be keeping an eye on some major domestic and global events in the coming week:

Note: all times are US EDT or the time in New York City.

  • Thursday July 25 at 6:45 AM – European Central Bank Interest Rate Decision. No interest rate change is expected but as with any Fed statement in the US, the language will be parsed for stimulus-friendly guidance.
  • Friday July 26 at 8:30 AM – Preliminary GDP estimate. Most analysts expect a quiet report in the 2.75% to 3.25% range, bracketing the expected 3.0% number, but with weakness to come in the second half of the year. Again, it would take a surprise outside the range to move markets.
  • Tuesday July 30 at 8:30 AM – The Personal Consumption Expenditure (PCE) inflation reading is a favorite of the Fed. It’s expected to come in at 1.5% below the Fed’s target of 2.0%. So even an “expected” would be good news for the market.
  • Tuesday July 30 at 8 PM – China NBS Manufacturing PMI. The bigger number (the China Caixin Manufacturing PMI) will come out 24 hours later but since the two are closely linked and this NBS number comes out before the Fed rate decision, it will be the bigger market mover this time around.

All those previous bits and pieces lead up to this one –

  • Wednesday July 31 at 2 PM – The Fed Rate Decision.

The Bottom Line

While we are in “The Upside Down,” these announcements will have the ability to move the markets more than usual — which means volatility.

Barring a cascade of great economic news (but don’t bet on that), the market will continue its current upward bias.

Great Trading and God bless you,

D. R.

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