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Why the Fed Won't Raise Rates Next Month

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In my blogs over the past several weeks we’ve been discussing the state of the financial markets. (See 3 Ways to Tell if a Stock Has Hit BottomIn Search of Return: 3 Biggest Market Risks and How to Play ThemGenerating Returns While Protecting Portfolios From a Crash), In this post, we’ll take a look at stocks, oil, commodities and the Fed. 

Stocks Edge Toward Fair Valuation

The Dow has closed lower every day for more than a week. It’s difficult to know if prices will stabilize or fall further. That said, there are two things of which we can be certain. First, we can determine if the broader U.S. stock market is over-, under- or fairly valued. Using the Total Market Cap to GDP ratio, stock valuations have fallen from a recent high of 127.5% on June 23, 2015 to a present level of 122.9% (a ratio of 100% is considered to be fairly valued).

Although stocks remain overvalued they are closer to fair valuation than they were six weeks ago. The other issue we can see is the selling and buying activity of an individual security. This is important because if buying activity is rising while a stock’s price is falling, it may be an indication of a trend reversal. This can be measured using the Chaikin Oscillator. A reading above zero indicates buying pressure while a reading below zero indicates selling pressure.

Oil Prices Still Falling

The spot price of crude oil (WTI, West Texas Intermediate) has been trending lower since closing at $59.47 on June 30, 2015.As I write this, it’s currently under $44.00. Why have oil prices been falling? There are three primary reasons.

1)      The U.S. dollar has been strengthening

2)      Production remains elevated, causing supply to rise

3)      The global economy has been weakening, reducing demand

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Is this some sort of economic war between OPEC and the United States? Perhaps. The winner will be the one with the lowest average cost of production. If prices continue to slide, more U.S. businesses will fail and the ripple effect will intensify.

Commodities’ Slide Continues

Commodity prices continue to slide due to a weaker global economy. This has hurt the world’s second-largest economy, China, which depends heavily on exports. As the majority of the world’s economies are slowing, the need for commodities is reduced, causing prices to fall. In general, commodity prices have been falling since August 2011. 

Fed to Raise Rates? I Doubt It

It should be noted that the U.S. yield curve has been flattening which is often an indicator of a weakening economy.

With all of the above as a backdrop, I doubt the Federal Reserve will raise rates in its September meeting.

Normally the Fed raises rates to keep the economy from over-heating which keeps inflation low. Today, inflation is tame (under 2.0%). In fact, the only justification for the Fed to raise interest rates would be to have some latitude in the event the U.S. economy were to weaken. Raising rates could also create greater demand for the U.S. dollar, causing it to strengthen further. This would be bad news for the profits of large U.S. multi-national corporations. 

Until next time, thanks for reading and have a great week!