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Peter Atwater: The Fed Coats Are Coming! And They're Bringing a Big Surprise...


The big surprise out of today's Fed meeting could be higher US interest rates and a decline in the dollar.

The clock is ticking ahead of today's Fed announcement like it's the launch of Apollo 11.

To believe the media, this one will be historic.

While we'll see about that, I would like to offer three thoughts ahead of the news.

First, I can't emphasize enough what the lack of a consensus "story" means in terms of the potential for a major move in rates.

At the lows in yields in 2012, not only did everyone believe that the Fed would implement QE3, the markets front-ran the news.

Investors acted on their extreme trust in what the Fed would do next.

At the beginning of the year, we saw a similar extreme consensus "story." As I shared in real time with my clients, in cautioning that a major bottom in yields was occurring:

"Put simply, the developed sovereign debt market, once a place where investors bought yield, is now a casino where price sensitive buyers bet on the actions of non-price sensitive buyers... The action of the group for whom price is everything is entirely dependent on the actions of those for whom price is meaningless."

Investors were once again front running policymakers -- this timing driving yields on many European sovereign debt issues negative.

We also saw a similar, consensus "story" at the other end of the confidence spectrum in mid-June. As I shared then, in suggesting that a major turn in yields was afoot:

"To believe the current market meme, the only possible move ahead in interest rates is higher."

With 75% of economists believing that a rate hike was certain and fixed income investors panicked about market liquidity, yields turned sharply lower.

A similar, and even more extreme, sentiment "story" occurred with the implosion of PIMCO in early 2014. The departure of Mohamed El-Erian and the subsequent resignation of Bill Gross marked a major peak in yields.

At major turns in the market, the market has one major "story." Everyone agrees and everyone is in. Even the contrarians have been shamed. I know, I've been there.

Today, there is no single story for the US Treasury market. This week's polling of economists splits the hike/don't hike vote right down the middle. No one knows for sure.

As a result, today's action by the Fed is far less important than the reaction. It is the story -- the new market narrative -- that matters. The story that comes out of the meeting is likely to form the basis for THE story that is universally agreed to at the next extreme in sentiment. 

Even more, given the market's current indecision, the speed at which THE story develops is likely to be very fast.

Right now, the see-saw has equally weighted people on either end. Beginning later today, one side or the other is likely to jump to the other side. As a result, the next move in yields is going to be very significant.

Second, I think the move in yields is higher not lower. My reasoning has nothing to do with the economy or global growth. It has everything to do with deteriorating investor confidence in the Fed and the growing dissention I see within the Fed's ranks -- itself a sign of weakening confidence.

In reflecting on the 30-year bull market in bond yields, I believe that a very strong and compelling story can be made that the entire decline in Treasury rates reflects growing investor confidence in the Fed and other global central banks.

As I have shared before, in 1981, investors were front running against the Fed.

In 2012, investors were front running with the Fed.

Since 2012, as I have detailed along the way, we have seen signs of declining confidence in the Fed. While small, the cracks have been forming. Even more, a group that once spoke as a single voice now has more than a dozen microphones.

That this headline was on the home page of Marketwatch on Tuesday speaks to the growing cacophony.

So too does the market's uncertainty regarding today's action. As others have highlighted, typically, the Fed signals its decision ahead of the meeting. Ahead of today's meeting, Janet Yellen has been silent for 63 days.

My concern with it all is that investors aren't just sitting on one side or the other on the see-saw evenly divided over the direction of interest rates.

They're sitting there divided over the omnipotence of the Fed, too.

Should the reaction to today's meeting suggest growing anxiety over the Fed's ability to control unfolding events, the move in rates could quickly turn violent.

I would watch for more headlines like this one from Fortune from yesterday morning.

The media follows mood. And to an omnipotent Fed, the consequence of falling confidence is binary. The Fed either is in complete control of the situation or has lost total control.

After you've been all-powerful, there is no middle ground. Just ask Oz.

Finally, while we could see a sharp hit to emerging markets currencies following today's meeting, I would be very careful to assume that the dollar will move higher along with US interest rates.

Emerging markets currency traders/investors have already front run today's meeting in size.

As I joked on Twitter earlier this week, "While 28% of economists think there will be a rate hike, 140% of emerging market currency traders do."

They're already all-in.

After an emotional pop, the big surprise out of today's Fed meeting could be higher US interest rates and a decline in the dollar.

Needless to say, that pairing is likely to capture many investors well offside.

Peter Atwater's groundbreaking book "Moods and Markets" is now available on Amazon and Barnes & Noble.
"Peter Atwater brilliantly provides a framework for understanding both the socioeconomic hubris that led to the great credit bubble of the past decade and the dark social-psychological hangover that has resulted from its collapse. In so doing, he offers an invaluable guide to what promises to be a very difficult and turbulent period ahead as we experience what he calls the 'me, here, and now' behavioral tendencies of the post-crash world."  -Sherle R. Schwenninger, Director, Economic Growth Program, New America Foundation

Twitter: @Peter_Atwater
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Position in SH, NUGT, GLD; Creditor of JPMorgan
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