Fed Will Still Raise Rates in December

June’s data came in weaker-than-some expected and the markets reacted; stocks reached new highs, oil and gold rallied, and rates fell.

  • June CPI 0.0 %, an improvement over May’s -0.1%
  • June core CPI +0.1%, the same as May
  • June industrial production +0.4%, an improvement over May’s +0.1% (which was revised from 0.0%)
  • June retail sales -0.2%, compared to May’s -0.1% (revised from -0.3%)
  • June ex-auto retail sales -0.1%, an improvement over May’s -0.3%

We do not see this data changing the FED’s future actions. Unemployment remains below the 5% target and is close to reaching full employment, CPI, while showing 0% growth, improved from the prior month, and when you take out energy (core CPI) you see +0.1% growth. A reduction in oil prices, and energy in general, also influenced retail sales since gas-station sales were down accordingly. The healthy +0.4% increase in industrial production continues to support the expansion phase of the business cycle. All this taken together, means that the slow pace of rate normalization that the FED has telegraphed to the markets will not change; we still think that there is a better than 50% chance of a rate hike in December and we continue to predict that wage-growth, while slow, will continue to respond to the low levels of unemployment.
The AAII sentiment indicators were little changed this week, with bull sentiment dropping 1.3%, neutral gaining 1.6%, and bear sentiment dropping an insignificant 0.2 %. This puts the bull-to-bear/neutral ratio at a bullish 28.2: 71.8. Fear has gone up even as equity markets make new all-time highs. This is not how bull markets end.
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The put-to-call ratio also indicates sentiment. When the ratio spikes up, it means that more puts than calls are being purchased and that investors are fearful. The chart below, shows how each time that the ratio spikes up (blue vertical dashed-lines) the S&P 500 rallies in response. At the moment, the ratio may have spiked and if it continues to decrease, then we expect equities to rally further.

Leaving sentiment, and going to a more “fundamental” indicator, industrial production has demonstrated a positive correlation with the SPX that goes back twenty-years. As reported in the introduction above, industrial production is increasing and as long as this is happening, the bull market will continue (chart below).

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We continue to maintain that interest rates have not changed their upward bias, that the business cycle is in a growth phase, that low unemployment will produce wage-growth, and that the FED will slowly, but surely start to reduce its balance sheet. We see this as putting gold in a catch-22 situation; if inflation stays low, gold gets pressured, and if inflation starts to rise, the FED is anxious to raise rates and squash it, which also will pressure gold. Medium and long-term, gold will continue under pressure.
The dollar and Treasury rates:

The USD/JPY ratio continues in an uptrend (chart below).

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The commitment of futures traders is also pointing to a rally in gold, short-term. When speculators reduce their long positions in gold, and the commercials reduce their short positions in gold, the price of gold tends to go up (chart below)

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