Monday September 19

Stocks were little changed as it gets closer to the FOMC raising rates. The S&P 500 finished at 2,139 and the Dow Jones finished at 18,120. Equities today rallied at the open on higher oil prices however optimism faded late in the session as oil priced eased lower. Utilities rose 1.1% while the KBW Bank index rose 0.5%. This week the BoJ and the Fed are both going to deliver updates to their current monetary policies. Analysts expect the BoJ to come up with a more flexible monetary easing strategy. Some researchers are also expecting an increase from Y80tn to Y100tn each month in stimulus along with another cut to its main interest rate from -0.10% to -0.20%. The Fed is not expected to raise rates on Wednesday. The market is pricing in a less than 20% chance of higher rates, and a 55% chance by the end of this year. The 10 year Treasury yield rose 2bp to 1.71% and the two year rose 1bp to 0.78%. The spread between 10s and 2s bear steepened to 0.93%. The dollar eased back against peers. USD fell 0.2% against EUR to $1.1178. USD fell 0.4% against JPY to Y101.82. USD fell 0.2% to $1.303. Oil prices finished slightly higher on the day. WTI rose 0.5% to $43.23 and Brent rose 0.3% to $45.89.

Eric Rosengren of the Boston Fed is a vocal advocate for tightening monetary policy. Rosengren is concerned for the economic costs associated with keeping interest rates too low for too long, which include economic imbalances and asset bubbles such as what is going on in the commercial real estate market. Prices have risen significantly for office buildings, warehouses, and apartment buildings. Outstanding credit into commercial real estate assets was as high as $3.6tn in March. Roughly half of that figure came from banks and the other half came in the form of investments on behalf of institutional investors. This is in part due to the search for yield, which has supported the commercial real estate asset class. According to Rosengren commercial real-estate prices would drop in the event of an adverse economic shock. Other members of the Fed don’t share this sense of urgency, arguing that high commercial real estate prices are not an immediate priority since other areas of the economy are not highly exposed to this sector.

The Fed would by all means catch investors off guard if they were to raise interest rates at Wednesday’s meeting. In spite of the rate selloff and stock market selloff that occurred at the start of last week markets are finally pricing in no rate hike. On the contrary both Jeff Gundlach and Bill Gross are skeptical, and believe the Fed may choose to surprise investors to show that the FOMC is not moving in response to investors. However Gundlach believes that 40% is the threshold that the market would need to be pricing in before the Fed raises rates. Anything less than that would shock markets and have very adverse effects on the financial system. Right now investors are also nervous about uncertainty regarding the ECB’s and the BoJ’s monetary easing programs, and the Fed likely will not want to add fuel to the fire. LIBOR has been rising significantly, which represents tighter financial conditions for banks and the Fed would not want to magnify that temporary effect.

Investors in Venezuela’s PdVSA bonds were not satisfied by the terms offered by the company in a bond swap proposal. PdVSA attempted to exchange $7bn in debt that is due in less than a year in exchange for debt due in 2020 with a coupon of 8.5%. The prices of the 2017 bond fell to 71.5 cents on the dollar, and bonds due sooner than that as well as the proposal did not meet investors expectations or hopes. Venezuela is facing low oil prices and reduced oil output. Investors have until September 29 to accept this deal.

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Monday September 19

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