US Employment data released this morning will not deter the US Federal Reserve from raising rates when it meets on Dec. 15 and 16 (in fact, it will likely raise the probability to above 80%).
When the Fed does raise rates, even by just 1/4%, in order to move market overnight lending rates higher (the market where banks lend to each other), they will likely have to drain liquidity from the system.
I read this morning that it could possibly be as much as $800B, basically the amount of liquidity that was added in the 2nd round of quantitative easing.
What does this mean?
It means that financial institutions (that deal with the Fed) will have to raise money by selling assets (stocks and bonds, etc.) into the market, adding supply.
This will come at a time when seasonal (year-end) factors tend to drain liquidity as well, so there may not be enough liquidity to handle the selling.
With limited liquidity, volatility may escalate further as this selling occurs.
Presumably the Fed will be taking this into consideration and will try to accommodate the system, however at some point, regardless, the market will have to absorb more supply from the asset sales.
If there is not enough buying to absorb the supply, it could quite possibly push both stock and bond prices lower to test buying support levels.
The down moves over the last couple of days in the S&P 500 highlighted a failure to break higher to test the May highs and the up-trend line from September was broken to the downside, followed by higher volume selling. The market will look to test buying support, which should happen at or about 2020, close to the November lows. If there is not enough buying support there, then the next level to test will be the August lows near 1870-1880.
If buying support returns to the market, the challenge is the now well-established down-trend line from the May and July highs which has continues to inspire selling.
The trend is established by lower highs (which we continue to see) and lower lows, which have not yet been tested. Until the trend becomes more established, we can classify the market as trading "sideways".
However, this does lower the odds for those who may have been hoping for the traditionally strong December market, often referred to as the "Santa Clause" rally.
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist