I will start with the acknowledgment that my expectation for the Federal Reserve (Fed) to increase rates was incorrect. The Fed decided to not raise interest rates at its meeting last week, citing uncertainty in global markets and low inflation. The reaction from markets has been a modest selloff in equities and about a 15 basis point decline in interest rates. The decision to not increase rates should have been positive for both stocks and bonds; however, the risk markets are trying to determine the implications of global uncertainty on equity valuations.
Uncertainty is never good for asset valuations, and the Fed citing this as a reason to wait only makes market participants speculate, "Does the Fed know something that we don't?" The other uncertainty discussed since the announcement has been that the Fed itself has created more uncertainty because of its own policy actions. What is the right environment to start normalizing rates? Central banks around the world have played an incredibly visible role in economies and markets since 2008, and it is becoming clear that they will not be able to remove themselves easily from this role without implications to economies and markets.
I expect the S&P 500 Index to trade range bound between 1850 and 2000 for the next few weeks until we start to get third quarter earnings, which I anticipate to be stronger than what we saw in the second quarter. That said, earnings per share growth will continue to be enhanced by debt-driven share buy backs, which give me concern about the quality of these earnings.
I also expect 10 year bond yields to trade between 2.10% and 2.30% in the next few weeks. Watch movements in emerging market equities and currencies for risk of a breakout either direction.
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