The Market Today
FOMC Expected to Begin Shrinking Balance Sheet for First Time Since 2010
by Craig Dismuke, Dudley Carter
This Week’s Calendar – FOMC Wednesday; Housing-Heavy Calendar: This week’s calendar is a housing-heavy week with reports on new starts (Tue), new permits (Tue), existing home sales (Wed), and FHFA home prices (Thu). The biggest of those reports will be Wednesday’s existing home sales given the recent weakness in both new and existing sales data. Starting this morning, we’ll see the September homebuilder confidence index at 9:00 a.m. CT which has been surprisingly resilient given some of the weak trends, of late. We chalk their confidence up to the historically low levels of inventories, the ability to pass on higher construction costs, continued low mortgage rates, and fewer competitors in the market than back in 2006. This morning’s index is expected to tick down from 68 to 67.
The biggest news of the week, however, will be Wednesday’s FOMC decision. We expect three primary results: 1) the commencement of the balance sheet reduction plan, 2) mixed revisions to the FOMC’s forecasts, and 3) unchanged forward-guidance language. As to the balance sheet plans, there appears to be unanimity on the committee to begin now. Regarding the SEP forecasts, like the Bloomberg Surveys of Economists over the past few months, 2017 GDP projections are likely to be revised up from 2.2% while unemployment rate and PCE inflation projections are likely to be revised lower. And the forward guidance language stating that risks are “roughly balanced” and the committee is anticipating “gradual increases” in the Fed Funds target are likely to remain intact. The biggest uncertainty is likely to be how the infamous dots are changed. As of the June SEP, the Committee expected one more hike in 2017 and 3 more in both 2018 and 2019. There were just four contributors who expected no additional hikes in 2017 versus twelve who expected one more. The recent run of weak inflation is likely to add to the column expecting no more hikes, but perhaps not enough to change the median. We will also be interested to see how the 2018 and 2019 dots evolve. Finally, this will be the first release of the Committee’s 2020 projections.
Overnight Activity – Equities Strengthen and Sovereign Yields Add to Last Week’s Rise as Markets Look to Wednesday’s Fed Decision: Market sentiment remains positive Monday with global shares mostly higher while sovereign yields (outside of Portugal) have changed little since Friday’s close. The MSCI’s index that tracks equity strength in the Asian Pacific, excluding Japan, rose 1.0% to an almost 10-year high; Japan was closed for a national holiday. The Stoxx Europe 600 advanced 0.26% to its second highest level since late July. Sovereign yields signaled a slight risk-on tone with safer sovereign yields of Germany and the U.S. inching higher and peripheral European yields in Italy and Spain falling modestly. Yields on Portugal’s sovereign debt stood out Monday with the 10-year yield down 28 basis points. Standard and Poor’s upgraded Portugal’s sovereign rating to investment grade (BBB-) for the first time since 2012. Shorter U.K. yields continued to adjust higher after last week’s hint from the Bank of England that it may hike in the coming months. In the currency market, the Yen continued to weaken as the recent risk-aversion abated further and the British Pound cooled after last week’s late-week surge. In the U.S., the Dollar was flat and equity futures improved against the stronger global backdrop. The Treasury curve is less than 1 bp changed except for the 1.2 bp rise on 7-year notes. After rising 15 bps last week, the 10-year yield is up 0.9 bps to 2.21%.
The Difficulty of Tax Reform (Stan Collender in Forbes): “There’s just one thing you really need to know about whether tax reform will happen by the end of this year: It’s about to take a very small group of senior policymakers more than six months to agree on the broadest of principles for what a tax reform plan should do … and the broad principles will be the easy part. … So how long is it going to take the House and Senate to deal with tax reform? In spite of the nuanced optimism you hear from The Gang of Six, it’s very likely to take much longer than it did for those six people – only four of which actually have votes – to agree on the generalities.”