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Market Update

Fed’s Not All: Bank of Japan, Housing Data, Geopolitics In Focus As FOMC Approaches

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September 18, 2017

(Monday Pre-Market) It’s Fed week, but there’s a lot more to it than just that. Investors might also want to focus on some key housing data as well as an interest rate decision by the Bank of Japan.

Meanwhile, there’s no end, seemingly, to the geopolitical issues that continue to pop up so often these days. North Korea’s latest missile launch over Japan and Friday’s bombing in a London subway both remind investors that outside events could lead to caution in the markets. However, that didn’t seem to immediately be the case, as the U.S. stock market posted new all-time highs Friday and defensive indicators like VIX and gold slipped.

The Fed meets Tuesday and Wednesday and a rate hike is the slimmest of slim possibilities. Fed funds futures put the odds at 1.4%. December is another question, with the market on Friday predicting a 55% chance of an increase in rates by then. That’s well above the 35% odds seen a week ago, and could reflect in part a more solid consumer price index (CPI) reading for August.

The bigger question going into the September meeting is what details the Fed might give about the unwinding of its $4.5 trillion balance sheet. Pardon us for sounding like a broken record, because this has been the same question going into the last couple of Fed meetings, and investors haven’t gotten much beyond vague clues. Prior to the hurricanes and North Korean crises over the last month, it seemed pretty clear that the Fed might announce something more substantial related to the balance sheet at its September gathering. The question is whether anything has changed.

Before the Fed’s pre-meeting silent period began, New York Fed President William Dudley told CNBC he believed the Fed would begin unwinding “relatively soon” and said the effects of the hurricanes would likely be “transitory” and might even lift economic activity in the long run. The balance sheet unwinding is considered important because it injects additional debt into the markets, where it might weigh on bond prices and cause yields to rise. That could affect borrowing costs, possibly slowing economic expansion. As of midday Friday, 10-year bond yields stood right at 2.20%, about the mid-point of their recent range and up from lows near the 2% mark earlier this month.

The Fed isn’t the only central bank holding a meeting this coming week. There’s also the Bank of Japan, which, like central banks in other parts of the world, has been embarked in a major stimulus program. The BOJ pledged last year to keep short-term interest rates at minus 0.1% and the 10-year bond yield around zero percent, but some economists familiar with the BOJ told the media that the BOJ might raise its bond yield target thanks to recent economic expansion. The BOJ statement is scheduled for Thursday. 

Aside from the bank meetings, there’s U.S. housing data to consider. Housing starts and building permits data for August are due Tuesday morning, followed by existing home sales on Wednesday morning. Housing starts pulled back pretty sharply in July, while existing home sales fell to their lowest seasonally adjusted level of the year. Supplies remain low and prices remain high, putting some pressure on home sales. On the other hand, mortgage rates are down from the start of the year, so that might provide buyers some incentive.

The last thing to consider going into the new week is a surprisingly weak retail sales figure for August released early Friday. The headline number fell 0.2%, and it represented the seventh-consecutive month of 0.3% or smaller growth. Some of the pressure in August might have been hurricane-related. Weak automobile sales, which could reflect Hurricane Harvey, played a role as well. Without autos, retail sales rose 0.2%. Even so, this trend of relatively weak retail sales raises some questions about consumer health and bears continued watching. 

VIX

FIGURE 1: DEFENSIVE DIP.

VIX fell to its lowest levels since the start of the month on Friday despite North Korea’s latest missile launch, while gold (purple line) also came down from recent highs. Lack of volatility here could signal that investors aren’t too worried about geopolitics getting in the way of the market. Data sources: CME Group, CBOE. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.    

Events Unfold, Market Trades On: Friday morning’s trading raised some eyebrows. The market opened with news of another North Korean missile launch over Japan and a bombing that wounded a number of people at a London subway stop. A few weeks ago, any saber rattling from North Korea seemed to stop the market in its tracks. The London terror attack seemed to add another twist to the international story. Instead of reacting to these events, however, the stock market appeared to shrug its shoulders and all three major indices posted new record highs. In addition, volatility didn’t kick up the way it did when North Korea conducted other provocative acts. In fact, the VIX fell back toward 10 by mid-morning Friday, its lowest level since the start of the month.

So What Gives? Some might wonder why the market didn’t really react much to these dramatic geopolitical events. There’s no easy answer and experts could disagree. One reason, however, might be the “been there, done that” mentality, meaning past European terror acts and North Korean provocations haven’t really led to much market impact beyond the first day or two. Investors tend to keep the past in mind, and since each North Korean saber rattling lately was followed shortly after by a market rally, perhaps many investors decided not to miss the bus this time and just climb on for the ride.

What the Survey Says: Michigan Consumer Sentiment for early September came in a little below Wall Street’s expectations on a morning when retail sales for August also disappointed. This could raise questions about how the consumer is feeling heading into fall and, dare we say it, holiday shopping season. Preliminary Michigan sentiment stood at 95.3, a little below analysts’ consensus for 95.5 and below the August reading of 96.8. The preliminary September report could be read in two ways, however. On the one hand, consumer confidence edged downward in early September “due to concerns over the outlook for the national economy,” said Survey of Consumers Chief Economist Richard Curtin, in a press release. Some of the negative sentiment seemed related to Hurricanes Harvey and Irma.

The positive news came in consumers’ assessments of current economic conditions, which reached the highest level since November 2000. “Renewed gains in incomes as well as rising home and equity values have acted to counterbalance the negative impacts from the hurricanes,” Curtin said. “Given the current resilience of consumers, recent events are unlikely to derail confidence.”

Good Trading,
JJ
@TDAJJKinahan

Economic Calendar

FIGURE 2: THIS WEEK'S ECONOMIC CALENDAR.

Source: Briefing.com

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