'Fed Fatigue' Has Set In

The markets are taking a breather from basing every move on the latest rhetoric out of the Federal Reserve regarding the timing of the first interest rate hike in nearly a decade. Traders are calling it “Fed fatigue.”

For months U.S. securities markets have been on a roller-coaster ride with each peak and valley predicated on whether the Fed is likely to move rates higher sooner or wait until later.

For instance, when it appeared over the summer that the Fed was gearing up for a rate hike in September markets fell as investors girded for the beginning-of-the-end of eight years of easy-money policies.

And when the Fed punted last month, voting to delay a rate hike until there was more clarity in particular over concerns that economic growth overseas was weakening, especially in China, the markets started moving higher again.

That’s how it’s been for a long time, pretty much ever since the Fed started hinting more than two years ago that it would begin winding down the unprecedented interventionist policies initiated in the wake of the 2008 financial crisis.

Now, for the time being anyway, investors are taking their cues from other places: Growing signs of an economic slowdown in China, anemic corporate earnings, a disappointing September jobs report, etc. Stock markets on Tuesday, for instance, flitted in and out of positive territory, trying to digest weak trade date out of China.

“Markets may also react to the ongoing confusion in Washington, as the clock ticks down towards yet another debt-ceiling deadline,” David Kelly, chief global strategist for J.P. Morgan Funds said. “Finally, investors will continue to keep a close eye on the on-going attempts of the Chinese government to bring more stability to both their economy and their financial markets.”

The shift away from ‘Fed-centric’ markets is a direct result of the mixed messages emanating from Fed policy makers.  On any given day a different member of the policy-setting Federal Open Market Committee offers his or her own take on why the Fed should either raise rates sooner or later.

Chicago Fed President Charles Evans, a noted inflation dove, twice in the past week has made his case that rates shouldn’t move higher until 2016. Evans wants more evidence that enough ‘slack’ has been squeezed out of U.S. labor markets to start pushing inflation higher toward the Fed’s 2% target range.

An influential group of FOMC members that includes Fed Chair Janet Yellen, Vice Chair Stanley Fischer and New York Fed President William Dudley have repeatedly said rates will likely move higher before the end of the year – but all three unfailingly hedge their public statements with assurances that nothing is written in stone and that monetary policy can and will shift if the incoming economic data shifts.

Meanwhile, Richmond Fed President Jeffrey Lacker, an inflation hawk, gave a speech last month titled, “The Case Against Further Delay.”

The vote to delay last month was based on fears that a premature lifting of interest rates could add to pressures – such as falling energy prices and weak wage growth -- already keeping inflation below the Fed’s target rate.

Policy makers were concerned that downward pressure on inflation could be exacerbated if short-term interest rates were raised “before it was clear that economic growth would remain at an above-trend pace and downward pressures on inflation had abated,” according to minutes from the Fed’s September meeting.

The reality is that no one – not even the 12 voting members of the FOMC -- has any idea when rates will actually start moving higher. It might be at the Fed’s meeting later this month, or (more likely) at the Fed’s December meeting. Or policy makers may decide to keep rates at their near-zero level into 2016 in an effort to ensure that the economy is strong enough to absorb the higher costs for borrowing that will follow a rate hike.