Stuck in the Doldrums——But The Markets Will Not Remain This Calm!

lance_HSIt’s only June 1, and it feels like the dog days of summer have arrived here in Florida. School is mostly out, humidity’s soaring, and we’ve already seen highs in the 90’s…

Even the markets seem to be treading water in ultra-calm seas. For instance, we didn’t really see the “sell in May and go away” phenomenon this year. Instead, the markets seem stagnant – stuck in the doldrums.

The “doldrums” is a maritime expression referring to a band of low-pressure that wraps around the equator and keeps the prevailing winds calm. The doldrums are also famous for periods of disappearing wind, leaving sailors stranded for days or weeks at a time on the high seas.

Can you imagine that? Stuck out there, watching your supplies dwindle and your skin blister… wondering if the winds will ever blow again…

Because that’s sure what it feels like to me in the markets rights now. We’ve seen a few periods like this in the past, but it has really been the case for the Treasury market this year.

Last week, several Fed officials let slip that a rate hike is still on the table later this month. That revelation barely nudged the long-term Treasury bond up from a 2.58% yield to 2.66%. Not a huge move.

Meanwhile, the Dow is trading just under 18,000 and the S&P 500 actually crossed back over the 2,100 level yesterday morning. Both are near all-time highs again.

Lately, it feels like the winds have deserted us!

Just look at the CBOE Volatility Index, or VIX.

The VIX is a measure of volatility for stocks. Historically, it trades near a level of 20 during normal times.

Well, we’ve been well below that level for most of the past eight months, or so!

The VIX spiked above 40 during the August selloff, got back above 20 a couple times leading up to the correction earlier this year, then backed off.

VIX May 2015-May 2016

Basically, the market seems to be holding its breath, waiting to see what the Fed does next.

The Fed desperately wants to get back to a more normal interest rate policy. It spent years trying to “fix” the economy with stimulation like QE, ZIRP and other measures, and now wants to ease back.

The Fed also knows that a wrong move can create chaos in the markets and that’s why doing anything differently, like raising rates, makes everyone nervous.

And the Fed understands its policy decisions ripple across the global markets, since the dollar affects, well, just about everything.

Generally speaking, a rate hike will likely strengthen the U.S. dollar. That makes goods and services from the U.S. more expensive for other countries and hurts U.S. corporate profits. It also has a major impact on all foreign currencies pegged to the dollar.

So, any attempts by the Fed to strengthen or weaken the dollar has an effect on those foreign countries. About 66 countries either peg their currency to the dollar or use it for legal tender!

China pegs its currency to the dollar because it exports a lot of goods here and gets paid in dollars. China has made headlines recently for unfairly weakening the yuan against the dollar. Basically, trying to gain an advantage in their U.S. exports.

Oil-exporting countries like Saudi Arabia have to peg to the dollar because their primary export is oil. Oil sells in dollars, so “oil” countries hold large amounts of our cash that they often invest in U.S. Treasury bonds.

Japan doesn’t peg to the dollar, but they also export a lot to the U.S. Japan’s central bank is also known for doing all it can to weaken the yen, in order to gain advantage here.

You get the picture. Since the U.S. dollar is the world’s reserve currency, there’s a lot of pressure on the Fed.

Fed officials know they could trigger a worldwide financial meltdown with the wrong move, and that’s why they’ve been so reluctant to act, so far.

Their credibility is now in question for not raising rates when some think they should, but the stakes are high, and the Fed knows it!

Lance Gaitan

Editor, Treasury Profits Accelerator