Sunday, September 23, 2018

FOMC preview: Prepare for the hawkish surprise

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses the trading component of the Trend Model to look for changes in the direction of the main Trend Model signal. A bullish Trend Model signal that gets less bullish is a trading "sell" signal. Conversely, a bearish Trend Model signal that gets less bearish is a trading "buy" signal. The history of actual out-of-sample (not backtested) signals of the trading model are shown by the arrows in the chart below. The turnover rate of the trading model is high, and it has varied between 150% to 200% per month.

Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Bullish*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.

Hawkish surprise ahead?
The FOMC is scheduled to meet next week for its September meeting. The market has fully discounted a quarter-point rate hike for the September meeting, and for the upcoming December meeting. Looking ahead to the March 2019 meeting, however, the market isn't fully convinced the Fed will continue its pace of quarter-point rate hikes every three months.

Peering further into the future, the CME's FedWatch tool for the June 2019 meeting shows that the market has only one rate hike penciled in between December and June.

Will the Fed pause as the Fed Funds rates nears neutral? The market thinks so. But I beg to differ for the following reasons:
  • Inflation pressures are rising, which will force the Fed to focus on its price stability mandate.
  • The Fed governors, including Fed Chair Jerome Powell, have shown little interest in pausing. Other key Fed officials have indicated that they are not afraid of inverting the yield curve.
In other words, prepare for a hawkish surprise from the September FOMC statement.

The full post can be found at our new site here.

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