Stocks rallied for a second straight day on Monday ahead of the Federal Reserve’s much-anticipated interest rate announcement, which is set for 2:00 p.m. ET on Wednesday.
In its Wednesday announcement the Fed is widely expected to raise rates for the first time since June 2006. Wednesday will mark exactly 8 years to the day that the Fed announced it would take interest rates to a record-low corridor of 0%-0.25%.
But first, the scoreboard:
- Dow: 17,532, +164, (+0.9%)
- S&P 500: 2,044, +22, (+1.1%)
- Nasdaq: 4,997, +45, (+0.9%)
And now, the top stories on Tuesday:
- It’s been a rough month and a rough year for the stock market and the last three days have been no different. Stocks got hammered on Friday, rose on Monday but not before bouncing all over the place first, and then soared on Tuesday. We’ll see what Fed Day brings. In an afternoon email, Rich Barry at the NYSE pointed to five main factors folks on the floor were throwing around for why stocks have been so volatile over the last few weeks: the Fed, oil, taxes, anticipation of the “Santa Claus Rally,” and Friday’s big quadruple options expiration. Barry added that at least one person on the floor expects Friday’s expiration to be the largest ever.
- But of course this really all about the Fed. You can read my colleague Akin Oyedele’s full preview of the announcement here, and he’ll also be handling the live the coverage on BI: Markets tomorrow. The important thing to know is that markets widely expect the Federal Reserve will raise its benchmark interest rate targets from 0%-0.25% to 0.25%-0.50%. Currently the effective Fed Funds rate falls in the middle of the range at around 0.13%, but in a note to clients analysts at Deutsche Bank said they expect the effective rate will fall closer to 0.32% instead of the 0.38% (or so) that would constitute the middle of the new range.
- Another part of the “mechanics” behind raising interest rates involves a likely increase in the Fed’s reverse repo facility, or RRP. Goldman Sachs expects the RRP’s cap to be increased from $300 billion to $750 billion, though a report from The Wall Street Journal back in April that made the rounds over the last few days suggested this facility — also crowned the “Death Star” by some commentators — could be unlimited after rates are initially raised.
- This all matters because the RRP is basically how the Fed gets the effective rate into its desired corridor. By taking in reserves via the RRP and sending out bonds to counterparties the Fed aims to sop up excess reserves in the system, thus pushing the effective borrowing rate in the banking system slightly higher. The thing is: the Fed has never raised rates with this many reserves sloshing around the system and so there has been some concern that rates could still trade below the Fed’s floor due to excess demand. Hence the potential for an uncapped facility. This really is a new world for financial markets.
- Inflation, the second part of the Fed’s dual mandate for full employment and price stability, was in-line with expectations in November as consumer prices on a “core” basis — which excludes the more volatile cost of food and gas — rose 0.2% on a “core” basis over the prior month and 2% over the prior year. CPI “sticky” prices, which excludes even more things than the “core” measure but is designed to be, well, even more stable, rose 2.42% over last year. The Fed, we’d note, is targeting inflation of around 2%.
- In less-compelling economic data, the New York Fed’s latest report on manufacturing activity in the region showed activity is still contracting though less than in the previous month.
- On the commodities front, natural gas futures fell to a 16-year low on Tuesday while crude oil prices actually rallied. A report out of Citi on Tuesday examined some of the new cost dynamics in the oil market, noting that cash costs have come down for “swing” producers like US and Canadian shale oil drillers. The upshot here is that as these costs — which measure the absolute minimum price these companies need to get to keep operations running — come down, companies are more likely to continue drilling, especially as they work to service outstanding debts. Remember the high-yield bond market (which was relatively quiet on Tuesday)? A lot of the stress in this debt is coming from the oil sector.
- Speaking of high-yield debt! Wall Street commentary has gotten particularly glum over the last few days following the blowout in high-yield credit and the halt in redemptions put in place by at least one distressed credit mutual fund. And while details will certainly continue to emerge about just what went down at Third Avenue and others, Matt Levine over at Bloomberg on Tuesday addressed the sort of basic choices you have if you’re running a mutual fund that promises investors the right to their money every trading day but don’t feel confident your market will give the same liquidity. In this position you either sit tight and meet redemptions, taking losses on some positions as you sell despite your best laid plans; or, you halt redemptions and move to liquidate the fund. We know that Third Avenue definitely elected to do the second, but is it because they didn’t feel confident they’d survive after pursuing the first? The SEC is asking.
- For those readers who want a reason to get bullish on stocks into year-end, Raymond James’ Jeff Saut has three reasons stocks could be in for a good old fashioned “rip-your-face-off” kind of rally. (I know: tough imagery.) Saut argued in appearance on CNBC Tuesday that right now the market is hugely oversold, facing a massive December expiration, and Santa Claus could potentially come to town. This is more or less what the NYSE’s Rich Barry had to say about why stocks could be headed higher from here, but it’s worth keeping in mind that while credit markets are highly unsettled and a major regime change could be coming from the Fed, classic stock market axioms are still being cited as potential “reasons” for something or other to happen. Whether these things apply anymore after seven years of zero interest rates or not is another question. But this is what’s out there. Still.
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