Today’s Economic & #Commodity Perspectives #Futures

FOMC meeting concludes today with a chance for a balance sheet announcement — The FOMC today concludes its 2-day policy meeting with the release of a post-meeting statement as usual.  There will be no post-meeting press conference today by Fed Chair Yellen.

There is virtually no chance for a Fed rate hike announcement today with the odds at only 12%, according to the federal funds futures market.  The odds for the Fed’s next rate hike then rise slowly to 22% by the Sep 19-20 FOMC meeting, 26% by the Oct 31/Nov 1 meeting, and 64% by the Dec 12-13 meeting.

Market expectations for Fed rate hikes through 2019 are far below the Fed’s expectations.  From the current level of 1.00-1.25%, the market is discounting an overall rate hike of only +60 bp (about 2-1/2 rate hikes) to 1.73% through the end of 2019, which is less than a third of the +188 bp rate hike to 3.00% anticipated by the Fed-dot forecast.

The only real question for today’s FOMC meeting is whether the FOMC will announce a start date for its balance sheet reduction program.  An announcement at today’s meeting would be somewhat of a surprise to the markets and would likely have a negative impact on T-note and stock prices since the market consensus is that the FOMC will make that announcement at its next meeting on Sep 19-20.

The FOMC may want to start its balance sheet reduction program on Oct 1, if only because the program would then sync with calendar quarters.  However, an Oct 1 start date could be problematic because the Fed cannot start its program until Congress raises the debt ceiling.  Congress may not raise the debt ceiling until after Oct 1 because the CBO says that Congress faces a deadline of early to mid-October to raise the debt ceiling.  However, the Fed could still announce an Oct 1 start date and simply add some contingencies based on the status of the debt ceiling.

The Fed has so far avoided any sort of taper tantrum in T-note prices tied to the balance sheet reduction program.  The Fed is trying to downplay any impact from the program, with several officials including Ms. Yellen favoring the analogy that the program will be like watching paint dry.  Nevertheless, the program will have some upward impact on Treasury yields since (1) the Fed is stepping away from the Treasury market as a big buyer, and (2) the Fed is permanently draining reserves from the banking system, thus tightening up liquidity.  If the Fed believed that the 2008-2014 QE programs were successful in stimulating the economy and supporting the financial markets, then the inescapable corollary is there will be a tightening effect of some degree as the QE programs are reversed.

New home sales expected to remain strong — The market consensus is for today’s June new home sales report to show a +0.8% gain to 615,000, adding to May’s +2.9% increase to 610,000.  New home sales remain in very strong shape at only -5.3% below the 9-1/2 year high of 644,000 posted in March.  There is strong demand for new homes even though the median price of a new home in May surged to a new record high of $345,800.  The supply of new homes also remains mildly tight at 5.3 months, below the long-term average of 6.1 months.  The June existing home sales report, released this past Monday, fell mildly by -1.8% to 5.52 million, leaving the series only -3.2% below the 10-year high of 5.70 million units posted in March.

Washington focus — The markets will continue to watch Washington with three major ongoing events of interest:  (1) the fate of health care legislation in the Senate, (2) the need for House Republicans to approve a 2018 budget resolution this week so there is a legislative vehicle for the tax reform reconciliation bill when it is formulated, and (3) the Russian investigation as interviews are expected today of Paul Manafort and Donald Trump Jr by Congressional committees.

5-year T-note auction to yield near 1.90% — The Treasury today will auction $15 billion of 2-year floating rate notes and $34 billion of 5-year T-notes.  The Treasury will then conclude this week’s $103 billion T-note package by selling $28 billion of 7-year T-notes on Thursday.  Today’s 5-year T-note issue was trading at 1.90% in when-issued trading late Tuesday afternoon.  That translates to an inflation-adjusted yield of 0.24% against the current breakeven 5-year inflation expectations rate of 1.66%.

The 12-auction averages for the 5-year are as follows: 2.44 bid cover ratio, $45 million in non-competitive bids to mostly retail investors, 5.0 bp tail to the median yield, 13.1 bp tail to the low yield, and 42% taken at the high yield.  The 5-year is moderately popular among foreign investors and central banks.  Indirect bidders, a proxy for foreign buyers, have taken an average of 63.0% of the last twelve 5-year T-note auctions, which is moderately above average of 60.2% for all recent Treasury coupon auctions.

Weekly EIA report — The market consensus for today’s weekly EIA report is for a -3.0 million bbl decline in U.S. crude oil inventories, a -1.8 million bbl decline in gasoline inventories, a -500,000 bbl decline in distillate inventories, and an unchanged refinery utilization rate of 94.0%.  The markets will be watching today’s report to see if U.S. oil production starts to plateau due to low oil prices and a stumble in new oil rigs, which have fallen in two of the last four weeks.  U.S. oil production in last week’s report rose by +0.3% w/w to a new 2-year high of 9.429 million bpd.