The long awaited day is finally here by which we, of course, mean the day when nobody has any idea what the Fed will do, the Fed included.

Putting today in perspective, there have been just about 700 rate cuts globally in the 3,367 days since the last Fed rate hike on June 29, 2006, while central banks have bought $15 trillion in assets, and vast portions of the world are now in negative interest rate territory.

As we noted yesterday, while the fed funds market implies a 32% probability of a rate hike one day ahead of the decision (which compares to 70% in 1994, 76% in 1999 and 92% in 2004) investors are even more torn, with 57% of respondents in an RBS survey saying the Fed should hike today, but only 42% expecting the Fed will announce a rate hike at 2pm. Of the 113 estimates on Bloomberg, 59 are calling for the Fed to stay put and 51 are calling for a 25bp hike, with the remaining 3 estimates calling for a 12.5bp move.

The Fed itself is not sure what to do: according to many a hawkish move would be not to hike but layer the statement with many caveats how strong the economy is (even as the Fed again chickens out) while the dovish thing would be a “one and done” rate hike with the Fed potentially unleashing a recession-inducing curve inversion.

Then there is the problem with the Fed’s rate hike machinery: the Reverse Repo-IOER corridor has never actually been tried in practice, only in very specific “in vitro” settings: at such a turbulent time will the Fed risk crushing its only possible and very much theoretical rate hike mechanism, and perhaps as importantly, with China undergoing currency devaluation and a massive capital outflow, will the Fed risk blowing up the entire Emerging Market complex (even more)?

Finally, unlike any other rate hike in the past, there are the algos to contend with: in the 2004-2006 rate hike cycle HFTs barely existed; this time the Fed’s “reaction function” has to take into consideration momentum ignition, spoofing, quote churning and countless other headline-driven market reactions.

So all eyes on the Fed’s website at 2pm, if not perhaps for Goldman’s – the firm that runs that Fed has spoken, and it see at least four more weeks of ZIRP, if not a zero-bound winter stretching well into 2016.

Should the Fed hike, the biggest question is not what stocks or the short-end of the Treasury curve do, but what the reaction of the long-bond is. After the usual initial kneejerk reaction, if the long-end concurs with the Fed’s view of economic recovery, then banks,
cyclicals and value stocks will receive a bid. Asset allocation toward “strong dollar” & “Fed tightening plays” will harden, with the exception that value will likely outperform growth. If the long-end rallies, signaling a policy mistake, then cash, volatility, gold &
defensive growth will be the way to go. Also, a quiet exit stage left may be prudent at this moment.

One thing that is certain is that while the Fed fiddles, China’s market manipulators continue to burn in ever more spectacular fashion, and while yesterday the SHCOMP entertained Chinese market watchers with a tremendous surge in the last hour of trading, today it was the opposite, when the Shanghai Composite Index fell 2.1% to close at sessions low at 3,086.06, sinking in final 15 minutes after gaining as much as 1.7% on light volume. 

“The market continues to be rather volatile with investors becoming bearish at the slightest indication,” says Gerry Alfonso, Shenwan Hongyuan director. “There seems to be significant expectations for some type of policy support.” Well, and the market gets them… every other day. Then on days like yesterday when it doesn’t, it panicks.

“The market is in recovering trend, but without any significant increase in trading volume to support that, greater volatility is inevitable,” Northeast Securities Shanghai-based analyst Shen Zhengyang says by phone, adding that “investors may be selling to lock in profits; there’s also uncertainty over Fed decision.”