FOMC Preview: What 2 Wall Street Pros Are Watching

The following are excerpts from Timothy Anderson and Kenny Polcari's morning notes. All text below subheaders is quoted. Disclosures are below.

Anderson Talks About The 'Biggest Challenge' Facing The Fed

• Once again Equity Markets find themselves at potentially a critical inflection point on the eve of a highly anticipated FOMC policy statement. While markets have battled all month over how to receive good news and bad news on the economic front, the ultimate rest could come today. Should the FED open the door for a June rate hike by removing "patient" from their verbiage it will be because they cite growth prospects improving, labor markets tightening, and wage growth as a catalyst for inflation getting closer to their 2.0% target. That would all be good news, right? Well, that depends on who you ask, and how sensitive their "model" is to interest rates being 0.25% after being 0.00% for 6 years.(insert extreme sarcastic emoji here).
• In my view, The biggest challenge facing the FED is breaking out of the habit they've been for close to 2 years of putting way too much thought into how markets will interpret and react to their policy moves and statements. Recall that at their FED meeting on May 22 and 23, 2013 the FED first introduced the concept of "tapering" their bond buying program as an initial step toward winding down QE3. Equity market investors and traders, having been spoiled by 4 years of ZIRP and 3 rounds of QE threw a now infamous "taper tantrum", and frankly, I don't think the FED has yet fully recovered from that. The FED, then led by Chairman Bernanke, then spent inordinate time and resources to convince markets that "tapering was not tightening" and that you'll still have ZIRP for a "considerable period of time"
• Recall that the FED had already dropped their initial 6.5% unemployment rate target, set at the beginning of ZIRP and QE1 as a target after which they would curtail QE and start to raise rates. Later they reassured markets that "rates could stay at zero for a "considerable period of time" after unemployment hitting their target if other factors warranted it. All of this "conditioned " markets to act like the "spoiled brat" they've become the last few years.
• The temper tantrum worked!!!! The FED was now as concerned about how markets interpreted their actions and statements, right or wrong, than whether their policy moves and statements were the proper prescription for executing on their Dual Mandate of Steady economic growth in an environment of low unemployment.
• After 6 years of ZIRP and 3 rounds of QE a much too large swathe of the market still finds intolerable the concept of normalizing monetary policy to match the steady, albeit agonizingly meager economic growth. As highlighted in a WSJ feature article Monday on levels of drug use and abuse by aging baby boomers, addiction to dysfunctional behavior is a terribly difficult habit to break.

Polcari, Meanwhile, Discusses Why The Fed Has 'Painted Themselves Into A Corner'

• Stocks continued their erratic behavior of the past couple of weeks.....just ahead of today's FED meeting announcement....so it is now T-7 hrs before the world finds out what Janet and her henchmen have decided to do with the word - 'Patience'.
• A quick look at the thesaurus tells us that she could now replace patience with a bunch of other like minded words - but in fact would be considered 'a change in policy'.....Will she say that the FED will maintain 'composure'? Or 'fortitude'. How about 'tolerant' or the always feel good mood enhancer of being 'calm, cool and collected'......or I love this one.....the FED will remain 'imperturbable'....just think of the fun the media would have with that word.....can't even say it without stumbling......perfect to keep everyone guessing....
• What is so interesting today - is that after the announcement Janet will be holding court in a Q&A session....so pay attention...this is where we will get CLARITY......Hahahahah - Human beings will ask questions and then automated 'headline reading algo's' will interpret the answer.....the algo will measure the tone of her voice and choice of words and the exact amount of time it took her to answer the question...from that the computer will assess the veracity of the statement and then automatically create either buy or sell orders based on its conclusion.............The quant guys have already loaded in a range of possible words so now the computers will figure out the possible combinations and permutations - see ...right back to 9th grade algebra.....
• The Fed has painted themselves into a corner with regards to interest rates. The problem is zero interest rates since 2009 and this has created a headache for the everyone....because the majority of people believes the Fed has no intentions of upsetting the status quo.....or the big investment banks that are so heavily invested as a result of current policy. Every time the mkt attempts to correct - the FED comes out and says - "What's up?" "Why worry?" So, every dip is bought because people believe in the "Fed put" idea, the idea that the FED can't allow a correction for fear of damaging these very banks. There has been an explosion in margin debt as a result....and this has created a bit of a bubble...in fact a big one.
• The Bank of International Settlements has been quite vocal on this...and has argued that if you let the bubble continue to grow, the bigger the mess when it bursts. Offshore lending in dollars now totals $9 trillion plus....Emerging mkts are under the gun and will be the biggest losers.....as they are getting deeper and deeper into debt which is why when the idea of higher rates is thrown out there - we see emerging mkts suffer the most.....so...what's next? Watch the language and watch the body language........
• Adding to a long list of recent negative macro data - is housing (again).....yesterday we learned that U.S. housing starts plummeted 17% to their lowest level in a year in the latest indication that the economy may not be so robust here in the 1st qtr.... Single-family building permits suffering the most - falling 6.2% to a 9month low.
• Yet, the gov't tells us that in March's jobs report constructions jobs were added – which leaves you to ask - what are they constructing? And this then just highlights the disconnect between the manipulated jobs report and unemployment report as nearly every economic report last month has missed the mark and missed significantly......adding to the argument that we are facing continued tough times ahead. Remember the Atlanta Fed's "GDP Now Forecast model" that we discussed last month? Well they just cut 1st qtr GDP again......taking it from +0.6% to +0.3% - following the most recent weak data.....
• So - today is all about the FED..... Should they remove "patient" and even suggest raising rates in June.....then look for the mkt to sell off.....because based on the 'data' she can't justify it - as she has said so many times......but in the context of raising rates to slow the explosion in margin debt and reckless behavior - then it might make sense...but that does not mean the mkt will take kindly to it......If she assures the mkt that policy essentially remains unchanged and rates are not guaranteed to go anywhere anytime soon...then look for a bit of a relief rally - but one that just tests the upper range around S&P 2100.

Polcari disclosure:

Anderson disclosure: