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Fed Watch Ramps Up: More Details on Balance Sheet Not Guaranteed

September 20, 2017

(Wednesday Market Open) It’s watch and wait this morning as the Fed gets ready to wrap up its two-day meeting. Stocks and bonds could be range-bound for a few hours, which they often are when investors look ahead to decisions by Fed Chair Janet Yellen and company.

Because the market has priced in essentially a zero percent chance of a rate hike today, it all comes down to what the Fed might or might not say about its $4.5 trillion balance sheet. The Fed seems likely to say something, but how much it reveals is anyone’s guess. Any move the Fed makes to begin unwinding could have an impact that’s similar to a rate hike, meaning it could send bond yields higher. Some of this might already be baked in, however, if you look at the 20 basis-point climb in 10-year bond yields over the last week (see chart).

Details are due at 2 p.m. ET when the Fed releases its statement, though judging from the way the financial sector performed on Tuesday you might think some sort of balance sheet announcement was a done deal. The financial sector climbed 0.8%, led by Citigroup (C), JP Morgan (JPM), Bank of America (BAC), and Goldman Sachs (GS).

As we’ve been saying, a rise in longer-term bond yields could help banks by making long-term loans more profitable (see chart), and financials have risen in seven of the last eight sessions. The sector still lags the SPX by a quite a bit year-to-date, however.

Bond yields moved higher Tuesday, ending the day near 2.24% for the 10-year Treasury note. That’s up from lows down near 2% earlier this month. The futures market now projects a nearly 60% chance of a Fed rate hike by the end of the year, up from around 35% earlier this month.

As we see so often on these Fed meeting days, the market had a lazy feel to it on Tuesday, with the S&P 500 (SPX) trading in a pretty tight range throughout the session. Still, all three major indices set new all-time highs and remain at lofty levels to start the day Wednesday.

Volatility, measured by VIX, dipped below 10 for the second-straight day and is at its lowest level in more than a month. Gold is down nearly 4% from earlier this month.

Telecom had an even better day Tuesday than financials. The beaten-up sector rose more than 2% amid media reports of merger talks between Sprint (S) and T-Mobile US (TMUS). Shares of both companies climbed sharply, helping lift the entire sector.

One company that had a rough time Tuesday was FedEx (FDX), which lowered its fiscal 2018 earnings forecast due to a cyber attack and the effect of Hurricane Harvey. Shares fell as much as 4% after the close. The question is whether the issues of the hurricane and cyber attack represent one-time problems or if there’s something to worry about longer term. The company is often seen as a good derivative for the broader retail market in this day of online shopping, so those who watch online retailers should consider asking whether the FDX problems are simply internal or if it’s the first sign of weakness in online retailers.

On the data watch, existing home sales and weekly oil inventories are both due later this morning. Oil prices rose back above $50 per barrel early Wednesday. The stock market isn’t likely to get spooked by oil prices unless they climb to $55 or higher, and rising oil prices might actually help the Fed’s case for tightening. 

Ten-Year Yield


Ten-year Treasury yields have certainly turned it around after posting 10-month lows in early September, and the financial sector, represented by the purple line, has followed along closely. A rise in 10-year yields amid optimism that the Fed might start to address its balance sheet has raised some hopes for improved bank profits. Data sources: CME Group, Standard & Poor’s. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

On the Home Front: Tuesday’s housing starts and building permits data didn’t shake the market’s foundations, so to speak, coming in not far from expectations for starts and above projections for permits. However, the permits number was high due to a big jump in multi-family permits last month, so new single family homes could remain in relatively tight supply. Data in coming months might see an effect from the two hurricanes, as well. Today brings existing home sales for August at 10 a.m. ET. Wall Street analysts expect a seasonally adjusted figure of 5.41 million, said. That would be little changed from 5.44 million in July, and speaks again to relatively tight supplies. Existing home prices have risen for 65 consecutive months year-over-year, and climbed a hefty 6.2% in July as inventories remain low. Watch to see if that type of housing price inflation continued in August. 

What Would “Unwinding” Look Like? The Fed said earlier this year that as part of its plan to “unwind” its vast balance sheet, it would allow a small amount of its bonds and mortgages proceeds to not be reinvested each month. The Fed stopped buying new bonds back in 2014, but it’s been reinvesting the proceeds of bonds that mature. By not reinvesting, the Fed could take relatively small amounts of debt off the market. The Fed hinted this could be light at first, in the range of $10 billion a month. However, the amount would likely rise each month. It’s possible the Fed wants to get started and see how the market reacts to small changes before accelerating the program, because there’s a lot of concern about what relatively weak inflation readings might say about the economy. 

Keeping Context: There’s a lot of bullish sentiment out there with markets at or near all-time highs. Take this in context and try not to get complacent. Instead, you might want to consider the record highs as a reminder to check your asset allocations and make sure the rallies haven’t pushed the stock component of your portfolio above levels you’re comfortable having.

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