September 25th, 2017 - Market Commentary
Crude oil bounced back up over $50 per barrel while safe haven gold (-2%) and U.S. Treasuries both lost ground (yields rose). Treasury yields and oil pushed above their respective downtrend lines that have been in place since March.
The Fed met last week, held rates steady as expected, and announced the beginning of the unwind of its $4.5 trillion balance sheet to begin in October. Balance sheet normalization is unlikely to have a major market impact due to the slow and methodical pace. Futures markets have jumped to a 63% probability of a 25bps rate hike in December, from below 40% only 2 months ago.
The Fed will cease reinvestment of $10 billion per month ($6b of UST and $4b of MBS), increasing by $10b per quarter until peaking at $50b per month ($30b of UST and $20b of MBS) of 'retired' interest income reinvestment.
The pace of the unwind translates to eliminating 'surplus' interest reinvestment by August of 2018 and a 'normalization' of the Fed balance sheet in late 2021 or early 2022. 'Normalization' depends on asset/liability structure of the Fed balance sheet but is likely $1 trillion to $2 trillion smaller than today's $4.5 trillion.
The S&P 500 is up approximately 1% thus far in September, on pace for a sixth straight monthly gain. September is historically a rather difficult month for the markets. September has delivered a rotation out of year to date winners (healthcare and technology) into year to date laggards (financials and energy).
A weak U.S. dollar, tight credit spreads, and strong equity markets are feeding into loose financial conditions reflected in many models closely watched by the Fed including Goldman Sachs, Bloomberg, Bank Credit Analyst, Chicago Fed, and Kansas City Fed. Loose financial conditions are providing room for Fed rate hikes despite low inflation.
The yield curve shifted upward in mostly parallel fashion, with the 10 year moving back up over 2.25%.
There were a good number of housing statistics released last week. Housing starts and building permits came in stronger than expected. New permits were the best reading relative to expectations since November 2015. Meanwhile, existing home sales came in near the lower band of expectations.
One interesting note is that the current level of housing starts is closer to the trough levels of prior recessions despite that fact that we are eight years into a recovery.
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