October 10 – Stock futures are again reflecting optimism this morning following comments made Monday by members of the Federal Open Market Committee increasing expectations that the central bank may be done with rate hikes in the current cycle. However, enthusiasm was limited by the continued escalation of the conflict in the Middle East as Israel retaliates against Hamas in the Gaza Strip. The VIX is trading below 18 at this hour, as it continues to slowly creep lower as trade fears of a wider regional conflict slowly ease. The dollar index is trading near an 11-day low 106.0. Yields on 10-year Treasuries are trading near 4.69% this morning, while yields on 2-year Treasuries are trading near 4.98%. Crude oil prices are modestly weaker as traders digest the Middle East conflict news, while the grain and oilseed markets are also modestly weaker.
Israeli rockets pummeled portions of the Gaza Strip today in retaliation to the weekend massacre by Hamas that killed nearly a thousand people while injuring many more, ignoring threats from Hamas that it would kill hostages that it took over the weekend, including many women, children, and foreign nationals. Israel stated Monday that one cannot appear weak in the Middle East, and that it “must” punish Hamas sufficiently so that it never does something so horrific again, while also sending a strong enough message to deter other terrorist organizations from the doing the same. That continues to support the risk that Israel may choose to also attack Iran, who it says funded the attacks from Hamas. Iran’s track record is to fund terrorist organizations that carry out objectives that parallel its own without being directly involved in the planning so that it can maintain the appearance of a respected member of the international community and avoid serious international sanctions. A broader regional conflict would risk the supply of crude oil coming out of the region due to direct damage to oil-related infrastructure, disruptions in shipping lanes, a decision to withhold oil from the West, or by sanctions on Iran. Direct sanctions take years to implement, so the immediate threat to the energy markets would be one of the other risks. Crude oil prices consolidated lower overnight, as traders chose to believe that the conflict will not expand regionally, but traders remain on edge as they continue to monitor headlines emerging from the region.
Rising energy prices present a risk to the economy, with fossil fuels impacting nearly every aspect of the economy, from transportation to packaging. The Federal Reserve monitors “core” inflation that excludes the volatility of food and energy prices, but sustained gains in energy prices eventually find their way into just about every other sector of the inflation equation. It’s one of the first things to show up in consumer surveys, as their perception of inflation is shaped by what they pay at the gas station and at the grocery store. A flight to safety tied to the outbreak of violence in the Middle East sent bond yields lower on the international market on Monday, whereas the U.S. market was closed for Columbus Day. Treasury yields initially went lower when they opened overnight, but they are currently recovering. Market action reflects attitudes towards the conflict in the Middle East, but it also reflects comments made by members of the Federal Reserve that suggest that the central bank may be done with rate hikes.
Fed fund futures put the odds of another rate hike this year at less than 28% this morning, down nearly 20 points from a week ago after members of the Federal Reserve suggested yesterday that rising Treasury yields on the long end of the yield curve need to be monitored, and that the central bank may need to reduce its own restrictive policy as a result. One can find a lot of theories about strength in the longer-term Treasury yields floating around Wall Street, but it comes down to an increased supply of debt certificates relative to demand, as I’ve previously outlined in this column. Analysts have largely been focused on Fed monetary policy and on the demand side of the balance sheet because few are willing to address or even consider the supply side of the equation. But the fact is that the government continues to increase the supply of Treasury debt certificates at a steady pace as it now essentially increases its borrowing to pay the rapidly rising interest costs on the national debt. The interest costs on that debt are now at $717 billion per year, which has doubled over the past year and it continues to rise as maturing debt certificates are rolled at today’s higher interest rates. It’s estimated by some that the supply of debt certificates will rise by 23% averaged across the yield curve in 2024 at a time when the Fed, China and Japan are decreasing demand for these certificates at an annual rate of close to $1.3 trillion. That requires higher rates to attract enough new buyers, aside from the Fed’s monetary policy.
Grain and oilseed prices continue to reflect weak demand for U.S. product in the absence of fresh headlines today that would suggest risk. Ample supplies of wheat from Russia and large supplies of corn and soybeans from Brazil at a time when both have a much weaker currencies combine with low water levels on the Panama Canal and the Mississippi River to make U.S. grain less competitive. The trade expects USDA to modestly reduce corn and soybean yields on Thursday, but it will likely also reduce export demand.
