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Jim Hyerczyk

Jim Hyerczyk

Fundamental and technical analyst with 30 years experience.

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Brace For Increased Volatility

On Wednesday, December 16, the U.S. Federal Reserve raised its key interest rate for the first time since June 29, 2006. In its monetary policy statement, the Fed cited numerous reasons for its U.S. rate decision. However, the move was primarily designed to keep a lid on inflation.

It’s interesting that at the time of the last rate hike to 5.25 percent, its highest level in more than five years, the Fed said that rising energy costs and a growing economy “have the potential to sustain inflation pressures.”

At the same time consumer prices, fueled by surging gas costs, were rising at a 4 percent annual rate and appeared to be accelerating. Even excluding the volatile food and energy categories, prices were rising at a 2.4 percent annual rate, well above the Fed’s upper target of 2 percent. Other commodities were also soaring near all-time highs, especially gold and food commodities, driven mainly by the falling U.S. Dollar.

Economic conditions have changed considerably since the last rate hike. This time around, the Federal Open Market Committee hiked rates because it believes that economic activity has been expanding at a moderate pace. It said that household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further, however, net exports have been soft.

The FOMC also said that a range of recent labor market indicators continued to show further improvement and confirmed that underutilization of labor resources had diminished appreciably since early this year. It also said that inflation was running below the committee’s 2 percent mandate, but blamed that on declining energy prices.

The key difference in the 2006 rate hike and the December 16 move is the way the Fed views the economy. In 2006, the economy was moving at a more robust pace. This time, the Fed says that economic growth is expanding at a “moderate pace”.

Energy prices are at multi-year lows. Gold and food commodities are also nearing levels not seen since 2006. The stronger U.S. Dollar is the main reason for the decline in commodity prices.

The U.S. Dollar is not only strengthening because of higher U.S. interest rates. It is also garnering support because the economies in Japan, Euro Zone and U.K. are still weak and their central banks are considering cutting rates further or implementing fresh stimulus measures.

In making the Fed announcement, Chairwoman Janet Yellen said the time is right for the U.S. to raise rates, but it will continue to monitor the impact of a rate hike on the economy. This is why traders believe the Fed will wait until at least June 2016 before making another rate hike decision.

This time around, the U.S. Dollar will benefit more from the Fed rate hike because the rest of the world’s major economies are still struggling. So the biggest impact this rate hike will have will be on the U.S. Dollar. A stronger U.S. Dollar typically leads to lower commodity prices so crude oil prices could continue to suffer during this money-tightening campaign.

February WTI Crude Oil

Technically, the weekly main trend is still down. The market tried to build support on the daily chart earlier in the week, but the short-covering rally was not strong enough to sustain the move and there was almost no evidence of speculative buying.

(Click to enlarge)

As of December 17, crude oil futures were poised to close on the weak side of a downtrending angle from the $40.69 main bottom. This week, the angle comes in at $36.44.

A sustained move under this angle will signal the presence of sellers. The angles also indicate that there is plenty of room to the downside with the next major target another downtrending angle at $32.19. We may not reach this level, however, since the chart indicates there is room to fall, traders should brace for increased volatility.

Additionally, the market will begin the week down eleven weeks from the last main top at $52.60. This puts it in the window of time for a potentially bullish closing price reversal bottom. However, it is going to take exhaustive selling pressure early in the week and a higher close at the end of the week to form this chart pattern. End-of-the-year profit-taking and position-squaring could also help reverse the market to up.

A reversal bottom will not mean the trend is getting ready to turn up, but it could lead to a massive short-covering rally since many short-sellers are looking for any excuse to begin booking profits. This should serve as warning to those who decide to short aggressively this late in the move.

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