All Eyes on the Fed (again)

The Federal Open Market Committee (FOMC) will meet on Wednesday, December 16th. Despite the pullback we have seen in the markets this week due to falling commodity prices, it seems very likely the Fed will raise interest rates. In a survey done by the Wall Street Journal, more than 97% of economists polled stated they believe the Fed will raise rates. The Fed-funds futures are pricing the “odds” of a rate hike at 85%. Most economists have cited the “readiness” to get the first rate hike out of the way and actually feel it would damage the Fed’s reputation if they do not raise rates.

We have been talking about the Fed raising rates for a few years now. It now seems that it is here, though nothing is certain. As we have said in the past, a rate hike isn’t necessarily a bad thing for the economy. For one, the Fed really took its time to make sure the economy was strong enough to withstand such a hike so a hike would actually indicate the Fed’s confidence in the strength of the economy. It seems as though most bond prices have already “adjusted” to the anticipation of a rate hike, so bond prices shouldn’t be too affected (though we will likely still see some movement). It is also important to review a chart we have used many times before when we previously discussed this topic. As you see on the chart below, while the 10 year Treasury yield rises, but stays below 5%, there is a positive correlation between yield movements and stock returns. Put another way, rate hikes are generally followed by rising stock prices, so long as the 10 year Treasury stays below 5%.
Crude Oil Prices Weaken:

The International Energy Agency (IEA) announced today that the current global glut of crude oil will continue through at least 2016 as producers have yet to scale back their oil production, despite the falling prices. Last week, OPEC ended its meeting without deciding on any production cuts and with Iran’s sanctions being lifted. The outlook for oil prices remains bleak, though there are a few factors that could change this. OPEC can back off the current market share war, something that would reduce the overall supply. However, this does not seem very likely from where we currently sit. The more likely scenario is that the U.S. and other non-OPEC nations begin reducing their supply of oil, thus cutting the overall supply. While this essentially concedes “victory” to OPEC, there are many producers that simply cannot economically sustain production when prices are at these levels, especially as the IEA has predicted a decrease in demand of oil for 2016. “There is evidence the Saudi-led strategy is starting to work. Oil below $50 is clearly driving out non-OPEC supply,” the report said.

China May Loosen Yuan’s Peg to U.S. Dollar:

The People’s Bank of China (PBOC) announced it may lessen the peg between the U.S. dollar (USD) and the Chinese Yuan (CNY). The PBOC announced that they feel it makes more sense to measure their currency against a basket of currencies. This was an unexpected shock that sent markets lower, as the markets essentially treated this as a CNY currency devaluation. The euro appreciated, as there is thought that the euro could be pegged to the CNY. The reasoning behind these moves is that, in order to peg the currency, the PBOC will need to sell USD to buy the euro. While it is a bit premature to gauge exactly what impact this will have, it does seem that the market is anticipating this as a bearish sign for emerging markets. China has long talked about doing this, but the timing seems to coincide with the pending U.S. interest rate hike.

 

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