Will the Market Be Bullied By the Fed?

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While the vast majority of investors probably don't have the time nor the interest in watching the stock market on a minute-by-minute basis, one can learn an awful lot about what is actually driving prices by doing so.

Granted, it isn't important to watch every tick, every moment of every day. However, when something happens and the market makes a big move, watching the action closely - meaning on a one-minute chart - can really help one understand why Ms. Market may be doing what she is doing.

For example, stock futures had been modestly lower before the open on Thursday morning. The spread between where futures were trading and fair value suggested that the S&P 500 might open down between 2 and 4 points. Yet, 5 minutes after the opening bell, the S&P was down 8 and dropping like a rock. And after 22 minutes, the S&P had lost nearly 15 points.

To be sure, a 15 point drop isn't anything to write home about these days - especially with the market having defied the majority of analysts by continuing to trudge higher since the middle of April. However, it was the manner in which the 15 S&P points came off that was the key.

In short, anyone expecting to see another sleepy summer morning in stocks was surely surprised by the sudden dance to the downside.

Take a peek at the 1-minute chart of the S&P shown below and you'll see what we're talking about.

S&P 500 1-Minute

So, given that the futures had been down between 2 and 4 points most of the morning, the quick decline meant that something was up.

Why The Dive? (Thursday Edition)

It turns out that something indeed had happened to cause the boys and their fancy computer toys to flood the market with sell orders. St. Louis Fed President James Bullard, who normally falls into the "dove" camp (i.e. the opposite of an inflation hawk), was talking about the Fed needing to raise interest rates sooner than expected.

Below is the tweet I sent out in an effort to provide followers with an explanation of the rapid, unexpected dive in stocks:

In essence, Bullard told reporters after a speech Thursday that an improving economy and rising price pressures (Fed-speak for inflation) means that the Fed is getting closer to the time when it will need to normalize monetary policy (Fed-speak for hiking short-term interest rates back to "normal" levels) - and that the markets may not be prepared for such a move.

"The Markets Aren't Ready"

Bullard's exact words were, "I don’t think financial markets have internalized how close we are to our ultimate goals."

Bullard added that after a miserable showing by the economy during the first quarter, he sees the economy moving back to a 3% growth rate and inflation rising back towards the Fed's target of 2%.

On the somewhat forgotten topic of the unemployment rate, Bullard said he sees the current 6.3% unemployment rate heading to 5.8% by year end. And if this happens, the St. Louis Fed President said the economy would be set up for the Fed to start normalizing their monetary policy.

When Will Rates Rise?

With regard to the idea of the Fed raising rates, Bullard added, "I’m starting to think the economy could tolerate at least a little bit of the central bank getting back to a more normal stance."

Then came the punchline. In terms of WHEN the Fed might take action, Mr. Bullard said that he believes the most likely timing for the Fed’s first rate hike would be near the end of the first quarter of 2015.

Although the timing mentioned did not represent a departure from Bullard's public stance, the key point was he said the Fed needs to begin the conversation about when exactly to raise rates. “I predict the conversation about monetary policy will change,” Bullard said.

All's Well That Ends Well

So, there you have it. Bullard says the markets don't appreciate how close the Fed might be to raising rates and wham, the algos started selling.

However, stocks then spent the rest of the day slowing recovering from the algo-induced dive and the S&P finished down just -0.14%. Thus, the dip buyers didn't appear to be too concerned about Bullard's comments. And, of course, the seemingly contradictory action in the market left questions about what the market's focus is at the present time.

So which is it? Will worries about the Fed raising rates sooner than expected cause more folks to start heading to the sidelines? Or... Is the REASON behind the Fed's potential move (i.e. recognition of the improvement in the economy) the key to the stock market's future?

We shall see. But the key is this is about to get interesting.

Positions in stocks mentioned: None

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