The Fed's New Dilemma

• Sentiment bolstered on softer US data
  

• Risk rally could fade quickly this time
  

• Fed managing global sentiment
  

• Better to hike than stay still
  

• Looking to sell SPX500, AUDUSD

MORE THAN SKEPTICAL - Amazing how the market has responded to last week's horrid US employment reading. While the reaction isn't surprising given it has been how the market has reacted to softer US data over the past several years, it is definitely a head turner at this point, now that the Fed is in a much different position. Clearly the Fed's lower for longer policy has fueled an intense wave of risk on flows that have resulted in record high US equity prices. But at this point, with the Fed now at the end of the rope and needing to consider policy reversal quite seriously, I am very skeptical that any rallies from here are more than corrective. In my view, the Fed's top priority is this new world economy is managing sentiment. And so, if the Fed wants to manage sentiment going forward, it may have to reconsider its lower for longer strategy.

FED INFLECTION POINT - There is now risk that lower for longer ends up weighing on stocks as the market is less encouraged by the incentive to be long stocks, with the Fed no longer having much left in the tank to further stimulate the economy. As such, at this point, it might be better for the Fed to bolster sentiment by offering some encouragement with its outlook for the US economy and letting the market know that we are finally ready to handle a 25bp liftoff. Either the Fed leaves rates as is and the markets sell off with the Fed having little else it can do, further intensifying the risk off trade, or the Fed hikes a mere 25bps, perhaps triggers a more controlled bout of risk off flow, but at the same time sends a positive message to the global economy. I think the latter is the way to go and I think the Fed still needs to be sending a message of a 2015 rate hike in the days ahead.

STRATEGY - With this in mind, my recommendation on the strategy front is to be looking to take advantage of this latest risk rally and selling into the strength. I like the idea of selling the SPX500 towards 2000 and like the idea of selling into an overdone AUDUSD rally towards 0.7200 today. Stand by.