Will They or Won’t They?

That seems to be the question on everybody’s mind this morning: At tomorrow’s FOMC meeting, will the Federal Reserve drop the ‘market friendly’ language stating that “policy accommodation can be maintained for a considerable period?” Fed watchers are arguing over that possible language change; it may very well turn out to be a Red Herring.

The issue is not “will they or won’t they;” Rather, its “should they or shouldn’t they?” How pre-emptive should the Fed be when it comes to inflation? That’s a reflection of your economic fears: Are you more concerned with inflation, or with weakening growth?

Our position is that continued fast growth is by no means assured – therefore the Fed can err on the side of leaving rates too low for too long. The economic expansion is not entrenched, job creation remains anemic, and there are still valid fears of deflation.

After three years of negative stock market returns – and a weak economy for nearly as long – the Fed can afford to be patient. It would be prudent to ensure the recovery is sustainable, and not merely a reaction to the extraordinary amount of stimulus in the system. There exists a very real possibility that consumer spending may slow, as the biggest effects of tax cuts and home refinancings fade in the rear-view mirror. Indeed, signs of softening consumer spending have already started to show up in the retail statistics. And while Business CapEx has improved, hiring remains muted.

The Fed meeting is set against a backdrop of possibly tiring markets. As the weekly (insert pun here) Nasdaq chart shows, relative strength of the technology heavy index is starting to weaken. This reveals a loss of upward momentum; Technician John Murphy notes that “weekly MACD lines turned negative this week for the first time in a year. That’s another sign that the Nasdaq rally may be running out of steam.” Murphy observes critical support is at the 10 week moving average (~1850) for the index.

This change in relative strength may be indicating more than a mere loss of Nasdaq momentum – it may also be a reflection of a rotation out of smaller technology issues, and into larger cap stocks, dividend payers, and blue chips.

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