Markets could begin to ignore Fed

Patti Domm | @pattidomm

Andrew Harrer | Bloomberg | Getty Images

Janet Yellen, chair of the U.S. Federal Reserve

 

 

In its statement, the central bank acknowledged the chances that inflation will stay below its 2 percent target, read as a hawkish sign by traders. But while pointing to improvements in the labor market and a lower unemployment rate, the Fed also noted that there remains a "significant under-utilization of labor resources," a dovish signal.

Stocks recovered some losses after the statement, but in the Treasury market, rates held near levels reached earlier in the session. Rates rose earlier in the day after a surprisingly strong report showed second-quarter GDP growth of 4 percent. Yields at the shorter end of the curve held multiyear highs. The two-year and three-year durations are where traders place bets on Fed rate moves. 

"The data is coming in very convincing now. They (the Fed) were a little bit slow to take action. Inflation has normalized and they did acknowledge that in this statement," said Nomura global currency strategist Jens Nordvig. "As time passes and very importantly as we get some hints that Q3 is also strong, they will have to adjust."

For that reason, markets will remain hyperfocused on data, particularly employment-related data like Friday's July jobs report. But Nordvig said the employment cost index, due Thursday, will be extremely important as the Fed closely monitors it.

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"Wages are actually crucial. I think if there is any movement in wages all bets are off," said Nordvig. He said the second-quarter employment cost report is expected to be up 0.5 for the period. "If there's an upside surprise, it will move the markets," he said. 

Strategists said the fact that Philadelphia Fed President Charles Plosser dissented over an objection to the Fed saying it would hold rates low for a "considerable" period also perplexed the market. Mark Luschini, chief investment strategist at Janney Montgomery, said that type of dissent could increase over the next couple of months. 

"This is going to be problematic for the market. At some point, if the economic data continues to show the kind of activity we've been seeing n the last two to four weeks, both in the labor market and PMIs, and to still have the Fed talking about keeping rates so low—they're setting up the market for an opportunity to be confused, and that could be a problem," said Luschini. 

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Nordvig said he would use the dip in the dollar after the Fed's statement to add to positons, and that he expects the dollar's recent gains to accelerate. The August through October period should be crucial because it is likely during that time that there will be a shift in Fed communications, he noted.
—By CNBC's Patti Domm