My call on what the Federal Open Market Committee (FOMC) would do at Wednesday's meeting was close to the actual result. I expected the Fed to freeze the federal funds rate at 2.25% to 2.50% through 2019, and the central bank did just that. My fresh outlook is that the next rate hike will be in December 2020 after the presidential election. There would have to be a "black swan" event for the Fed to change this thought process.
Regarding the Federal Reserve balance sheet, I expected the unwinding to continue until later in the year. The Fed put a time stamp on the unwinding, saying it will stop at the end of September. My call is that this is an unwind pause and that unwinding will resume after the presidential election in 2020.
I come to this conclusion given how Chairman Jerome Powell responded to a question raised during his press conference that followed the FOMC statement. The question was how large the balance sheet will be when the unwinding ends. His response was $3.5 trillion, which would be a total unwinding of $1.0 trillion.
The new unwinding schedule calls for a drain of $50 billion in March and April, then down to $35 billion over the next five months through September. This would total an unwinding of $275 billion. With the balance sheet now at $3.971 trillion, it would move down to $3.696 trillion. This would mean that another $196 billion would have to be drained on a subsequent restart of the unwinding after the presidential election.
Beginning in October, the Fed will be allowing $20 billion per month of agency securities to run off, but they will be replaced by U.S. Treasuries. Most unwinding transactions will continue to occur as securities mature. U.S. Treasuries mature on the 15th of the month for some cycles or at month end for other cycles. When a Treasury matures and the Fed needs to reinvest, it will buy the new issue in the same cycle on a noncompetitive basis.
One issue that I disagree with is that Fed Chair Powell told his press conference audience that unwinding the balance sheet is not tightening monetary policy. How can it not be? Unwinding quantitative easing is quantitative tightening, as money is drained from the banking system!
The yield on the 10-Year U.S. Treasury Note
The weekly chart for the 10-Year U.S. Treasury Note yield clearly shows that the decline in yields began from a high yield of 3.26% set during the week Oct. 12 as the stock market peaked. This week sets the lowest yield from this high at 2.50%, which is approaching the 200-week simple moving average, or "reversion to the mean," at 2.15%. The decline in yield has the note below my quarterly and semiannual pivots at 2.771% and 2.863%, respectively.
Daily chart for the SPDR S&P 500 ETF
The daily chart for the SPDR S&P 500 ETF (SPY), also known as Spiders, shows that the fund held my monthly pivot at $281.13 after the FOMC meeting, giving bulls the opportunity to buy, as my targets remain my weekly and annual risky levels at $284.74 and $285.86, where profits should be taken. My semiannual pivot lags at $266.14, with my quarterly risky level at $292.04, which is below the all-time intraday high of $293.94 set on Sept. 20.
Weekly chart for the SPDR S&P 500 ETF
The weekly chart for Spiders is positive but overbought, with the ETF above its five-week modified moving average at $276.26 and well above its 200-week simple moving average, or "reversion to the mean," at $238.46. Note how this key average held at the Dec. 26 low. The 12 x 3 x 3 weekly slow stochastic reading is projected to end this week at 90.35, well above the overbought threshold of 80.00 and above 90.00, which I consider an "inflating parabolic bubble."
How to use 12 x 3 x 3 weekly slow stochastic readings: My choice of using 12 x 3 x 3 weekly slow stochastic readings was based upon backtesting many methods of reading share-price momentum with the objective of finding the combination that resulted in the fewest false signals. I did this following the stock market crash of 1987, so I have been happy with the results for more than 30 years.
The stochastic reading covers the last 12 weeks of highs, lows and closes for the stock. There is a raw calculation of the differences between the highest high and lowest low versus the closes. These levels are modified to a fast reading and a slow reading, and I found that the slow reading worked the best.
The stochastic reading scales between 00.00 and 100.00, with readings above 80.00 considered overbought and readings below 20.00 considered oversold. Recently, I noted that stocks tend to peak and decline 10% to 20% and more shortly after a reading rises above 90.00, so I call that an "inflating parabolic bubble," as a bubble always pops. I also refer to a reading below 10.00 as "too cheap to ignore."
Disclosure: The author has no positions in any securities mentioned and no plans to initiate any positions within the next 72 hours.