TRADING THE WEEK: Market Meanders Post-FOMC

Now that the Federal Reserve has raised short-term interest rates and the market has digested its statement, traders are relaxing and letting stocks trade a bit directionless.

Looking back last week, after its two-day policy meeting, the Federal Open Market Committee voted to raise the range of the federal funds rate to 0.75% and 1.00%, citing progress in labor market growth, business fixed investment and inflation. The move was widely expected.

“In view of realized and expected labor market conditions and inflation, the Committee decided to raise…the fed funds rate,” the central bank wrote in its statement.

One member of the committee, Minneapolis Fed President Neel Kashkari, voted against the decision, preferring to keep the federal funds rate between 0.50% to 0.75%. Kashkari is a new voting member of the FOMC this year.

Lone wolf Kashkari voted against last week’s policy move and has been public voicing his concerns that the U.S. economy is still underperforming when it comes to job creation and there are few to no signs of inflation.

Even after the data support tightening, Kashkari said in a statement, the Fed should wait on raising interest rates until it publishes a detailed plan for how and when it will reduce its $4.5 trillion balance sheet.

The debate now looks to be how many more times the Fed will hike rates – with some traders betting on one more time while others say two more hikes will come. The consensus is for two more rate hikes – totaling no more than 50 basis points. But with the FOMC done - for now – the market is back to eyeing and pondering valuations and Presidential policies.

“We’re looking at a market now that has gotten what it wanted -- a rate hike -- and now is taking a pause to adjust and reflect on itself,” said a floor trader. “The market isn’t going to make any dramatic moves to upside or downside. Everyone is talking about valuations being high – so there’s limited upside. But there doesn’t seem to be any conviction that they are too high, as no one is really selling.”

Trading on U.S. equity exchanges reflected the general market malaise as volume was reported at an average 6.78 billion shares for the week ended March 17, just up slightly from the 6.76 billion shares per day for the week ended March 10, according to Bats Global Markets data. Prior to the US jobs report, volume spiked and averaged 7 billion shares per day or better.

With continued bullish economic news, favorable economic developments out of Washington, such as higher defense spending and no change in overall spending, market conditions seem ripe for a continued rally in U.S. equities, said William Mingione, Managing Director – Head of Equities at Drexel Hamilton.

“The president’s budget seems to be a positive overall for stocks but the proof will be in the pudding.  We continue to see lots of buy orders in the financial sector but the sector does not seem to be rallying as much as we would expect,” Mingione said. “This to us seems like it could be the sign of a pause in the sectors rally. We are also a little concerned about the REIT space as we feel the analysts are starting capitulate with two large banks downgrading the sector this week. We could be seeing a short-term bottom in the trading of the REIT space with this happening.  There’s nothing to exciting ahead next week for the market to focus on.”

In other market news, Virtu Financial made an unsolicited offer to buy KCG Holdings common stock for $18.50-$20.00 per share in cash, valuing the company at as much as $1.33 billion. And while the deal looks large, it is really about little things – the mom-and-pop trading orders for securities – that on their own seem insignificant - but when grouped into wholesale lots by firms’ like KCG translate into big business.

David Polen at ‎Fidessa said that the potential acquisition appears to be a grab by the HFT firm for retail order flow, which wholesaler KCG has a solid foot in.

Credit Suisse in its latest trading research noted that profits for market makers, such as Virtu, have slumped in recent years and one trader at a regional broker thought this was the driver for an acquisition. Virtu, could by acquiring KCG and its valuable retail order flow, boost profitability and help it grow.

“Market making is not as profitable as it once was,” said the regional trader. “So, in order to boost profits and tap into some of that rich retail order flow Virtu decides to make a play for KCG. And KCG’s star has been on the rise – making technology and people investments.”

Retail order flow is big business. According to KCG, Bloomberg and RegOne estimates, monthly retail order flow currently runs about net $30 billion in equities. Over the long run, retail order flow has grown from $10 billion in US equities in 2010 to just under $300 billion in 2016. In January, the most recent available period, KCG had 32.01% of retail volume as measured under rule 605 Eligible Volume requirements.

Also, the exchange-traded fund sector continues to be the darling of investors. Against the backdrop of the S&P 500 Index up 3.7% in February and 5.6% year-to-date (as of 2/28/17), investors continued to turn to ETFs to increase their equity exposure, as $32.5 billion of net new assets flowed into equity ETFs during the month, according to the US ETF Flash Flows report from State Street Global Advisors.

Lastly, the buy side could trim back as much as $200 million on research spend in the U.S. alone, and over €100 million in Europe over the next 12 months, based on a new Greenwich Associates report and estimate. The reason is MiFID II, the regulation set to go into effect in January 2018.

This Week’s U.S. Economic Indicators of Interest: