FOMC today will likely go ahead with a rate hike despite government shutdown and junk bond uncertainties — We expect the FOMC today to go ahead with a +25 bp rate hike despite the uncertainties caused by the current turmoil in the junk bond market and by the chance for a U.S. government shutdown if Congress cannot agree on an omnibus budget bill. The federal funds futures market is discounting a 76% chance of a Fed +25 bp rate hike today, little changed from recent levels. A 25 bp rate hike would push the new funds rate target up to 0.25-0.50% (from the current zero-0.25%) with a new mid-point of 0.375%.
Jan crude oil prices on Tuesday rebounded upward by +$0.79 (+2.18%) to $37.10 per barrel, thus giving the U.S. stock market an overall boost and providing some relief to the junk bond market. The $15 billion iBoxx High Yield Corporate Bond ETF (HYG) on Tuesday recovered by +1.6%, rebounding higher from Monday’s 4-year low and reversing part of the Fri/Mon loss of -2.9%. Tuesday’s upward rebound in the junk bond market may give the FOMC members a little confidence that the junk bond market is not about to spark systemic problems in the U.S. financial system.
Meanwhile, the chances for a protracted U.S. government shutdown appear to be very low as Republicans and Democrats near a final agreement on both the omnibus budget bill and the tax extenders bill. The FOMC could therefore go ahead with a rate hike today without being overly worried about a protracted U.S. government shutdown that could cause significant damage to the U.S. economy.
Since virtually everyone is braced for a Fed rate hike today, the big news will actually be the extent to which the Fed in its post-meeting statement language and in the Yellen post-meeting press conference provides reassurance that the Fed’s rate-hike regime will be slow. The markets at present are not fully discounting the Fed’s next 25 bp rate hike until the September FOMC meeting, meaning that there will be a huge amount of time for the Fed to decide whether the U.S. economy and the financial markets are ready for another rate hike.
But what happens if the Fed surprises the markets and keeps its funds rate target unchanged at 0.00-0.25%? The dollar would clearly take a hit and that would be bullish for commodity prices, providing a little relief for oil and gas companies and the junk bond market. An unchanged Fed policy today would theoretically also be supportive for the U.S. stock and bond markets.
However, many market commentators will be howling if the Fed doesn’t raise interest rates today based on the idea that the Fed is really bad at signaling its intentions. If the Fed doesn’t raise interest rates today, the Fed will clearly take a hit to its credibility. The bond market will start questioning whether the FOMC has any spine at all or whether the FOMC is going to delay a tightening until it’s too late, i.e., when inflation has gotten out of control. In that sense, the lack of a Fed rate hike today could end up being a long-term bearish factor for the U.S. bond market due to the implication of a lack of resolve at the Fed. We believe that most market participants will be happy with a rate hike today in the sense of getting the move out of the way and moving on towards a more normal monetary policy in the future.
Congress is looking at a 1-week CR to avoid a government shutdown tonight — Congress is expected to approve a 1-week CR today to give themselves more time to consider the budget legislation. Without a new CR, a U.S. government shutdown will begin at midnight tonight. At this point, the House is expected approve the budget deal on Thursday, then forwarding it to the Senate for its approval either Friday or during the weekend. It is not yet clear whether the omnibus spending bill and the tax extenders bill will be voted upon separately or as a package. It is now clear that the Fed today will have to make its decision on an interest rate hike without knowing for sure if there will be a U.S. government shutdown. However, the odds appear low for a U.S. government shutdown since the differences between Republicans and Democrats are now reportedly small and since there are no strident calls for a U.S. government shutdown.
Housing starts expected to recover somewhat after Oct’s sharp decline — The market is expecting today’s Nov housing starts report to show an increase of +6.6% to 1.130 million, recovering part of October’s sharp -11.0% decline to 1.060 million. Housing starts posted an 8-year high of 1.21 million units in June 2015 but have since seen some weakness due to the August stock market correction and cautiousness among U.S. home builders.
Industrial production expected to show another decline — The market is expecting today’s Nov industrial production report to show a decline of -0.1% m/m, adding to Oct’s -0.2% decline. Meanwhile, the market is expecting today’s Nov manufacturing production report to be unchanged m/m after Oct’s +0.4% increase. The U.S. manufacturing sector continues to see downward pressure from the petroleum sector recession and from weak exports.
Weekly EIA report — The market consensus for today’s weekly EIA report is for a -600,000 bbl drop in U.S. crude oil inventories, a +1.0 million bbl increase in gasoline inventories, a +1.8 million bbl increase in distillate inventories, and a +0.6 point increase in the refinery utilization rate to 93.7%. U.S. crude oil inventories are +33.6% above the 5-year seasonal average, gasoline is +0.6% above average, and distillates are +13.3% above average.
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