Perspective: Morning Commentary for December 17

Perspective: Morning Commentary

Arlan Suderman

Chief Commodities Economist

December 17- The Federal Open Market Committee is the focus of Wall Street the next two days, with the central bank expected to announce changes to it monetary policy tomorrow afternoon. Stock futures pulled back overnight ahead of the start of today’s meetings, with the Nasdaq seeing a pullback from yesterday’s record high. The VIX firmed to trade near 15 overnight, reflecting a slight rise in nerves on Wall Street ahead of this week’s Fed decision, while the dollar index is trading near 106.9. Yields on 10-year Treasuries rose to four-week highs near 4.44% this morning, while yields on 2-year Treasuries hit 4.30% as the yield curve slowly steepens. The broader commodity sector also felt modest headwinds this morning, with crude oil prices pulling back from overhead chart resistance above $71 per barrel, with the grain and oilseed sector mixed.

Retail sales rose 0.7% month-on-month in November, up from an upwardly revised 0.5% in October, and above analyst expectations of 0.5%. Retail sales minus vehicles rose 0.2% month-on-month in November, matching an upwardly revised 0.2% pace the previous month, but down from analyst expectations of 0.4% growth. Retail sales minus vehicles and gas had similar numbers. Overall, retail sales were up 3.8% year-on-year. The numbers failed to impress, but they also failed to raise big alarms on Wall Street.

Fed fund futures are trading 97% odds of a 25-basis-point rate cut tomorrow, but Treasury yields are posting their highest levels since mid-November. There are market expectations of Fed monetary policy, and then there is the reality of what the market does that tends to lead monetary policy. The Fed made its objectives clear at the September meeting when it aggressively cut its benchmark rate by 50 basis points, signaling that the war on inflation was essentially over – we just needed to coast down to the 2% level – and that its unemployment mandate was now the central focus. That meant getting the benchmark rate down to its “neutral” rate to stimulate economic growth for improving labor market conditions, although they admit that they don’t know what neutral is.

But a lot has changed since the November meeting, and I would argue that these changing dynamics have elevated the neutral rate. First, the Fed’s 50-basis point rate cut, and the rhetoric that came with it, had a significant stimulative effect on the economy. Consumer confidence began to rise on expectations that lower interest rates would spur the economy, therefore the consumer became a more confident spender for all things except those big-ticket items that are interest rate sensitive. After all, they had been told that interest rates would be much lower in six months, so why not wait. However, the market was already trading those lower rates, and yields began to rise again anticipating the growth that was yet to come from the shift in monetary policy. Another boost came in November when a pro-growth president was elected who promised to extend the 2017 tax cuts, while adding new tax cuts to the mix and while cutting regulations. The National Federation of Independent Businesses that represents America’s small businesses saw its optimism index soar, as business owners made plans to expand in this environment.

Fed Chair Jerome Powell stated that the Fed would wait for hard policy decisions before changing course following the election, but that’s contrary to his actions of eight years ago, and I suspect that we’ll find that Powell and his staff have been busy analyzing anticipated fiscal policy changes for a potential pivot in monetary policy as well. Look for the product of that analysis to show up in tomorrow’s numbers, with policymakers upwardly revising their growth and inflation projections, while also reducing their rate cut expectations. Keep in mind the dirty little secret in Washington is that tax cuts typically increase revenues – not reduce them – as the economy grows as a product of the stimulus, especially when combined with deregulation. And we didn’t have inflation with the tax cuts and resulting economic growth in Trump 1.0 either. The inflation didn’t come until we overstimulated the economy during the pandemic with massive fiscal and monetary cash injections into the economy that continues to give us lingering inflation.

A record $600 billion of investment money flowed into the global bond market this year to take advantage of the highest yields that we’ve seen in more than 15 years. That actually helped cap yields as demand for debt certificates remained strong. But rising rates in Japan are bringing money back home. Japanese investors are the largest foreign holders of U.S. fiscal debt certificates. Furthermore, retail investors see the tech sector making record highs, while the Fed tells them that interest rates will be going down, giving some a sense that perhaps they should shift their back away from the Treasuries. Meanwhile, the supply of debt certificates is expected to hit record high levels as Congress continues its massive deficit spending. Thus, Treasury yields are going higher despite expectations that the Fed will cut rates. In the end, the market is sending a message to members of the Federal Reserve. Tomorrow, we’ll learn if they are listening to these market signals.

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Perspective: Morning Commentary for December 17

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