December 14, 2015
Prior Week Summary
After nearly a decade since the last increase in the Fed Funds target rate, the Fed is widely forecasted to achieve lift-off following the Wednesday meeting of the Federal Open Market Committee. As of this writing, the market implied probability of a hike on Wednesday stands at 78%, with the 2-Year Treasury note offered at 93 basis points. It is striking that with only 2 days left until the decision, there would be as much lingering doubt about this widely telegraphed outcome among market participants. The percentage of investors in the “no-change” camp have grown increasingly concerned about the continued decline in commodity markets and the nascent struggle in the high yield bond markets. To be clear, the probabilities implied in options pricing don’t represent a true survey of investors, but the results can be instructive.
Indeed, as of this morning, the price of WTI Crude Oil has fallen below $35 a barrel, the lowest level since 2009, as Iran has reiterated its plan to boost crude exports into an already oversupplied market. The decline in the crude oil price has been striking in its speed – a decline of 18% since the beginning of the month, and 8% since last week. Several market analysts have calculated that the oil price will need to return to the mid $50s by the end of next year for the CPI basket to register inflation in-line with the Fed’s target.
Additionally, the recent spate of trouble in the high-yield market has given many investors cause for concern, with some going so far as to analogize the experience to the BNP Paribas and Bear Stearns funds that proved to be a harbinger of the mortgage crisis. The $800mm Third Avenue Focused Credit Fund announced last week that it would be halting investors’ withdrawals, a $400mm fund managed by Stone Lion Capital Partners also suspended redemptions last week. Finally, over the weekend, Lucidus Capital Partners announced that they had liquidated their entire $900mm high-yield credit portfolio, in response to a large redemption request from an investor in the fund. Traders in the high-yield market have said liquidity is poor and price discovery has been difficult to come by, as yield spreads to Treasuries gap higher. Only time will tell if these relatively small events will prove to be signal or noise.
The Look Forward
In addition to the Fed announcement midweek, the data calendar is quite heavy with a number of tier-1 data releases on deck. Empire Manufacturing and CPI on Tuesday, Housing Starts, Building Permits, and Industrial Production on Wednesday, and the Current Account Balance on Thursday. The government will sell $16bb in 5-year TIPS on Thursday.