September 20 – Stock futures had a positive tone to them overnight ahead of today’s highly anticipated monetary policy decision from the Federal Reserve. The VIX continues to trade near the 14 level, while the dollar index is trading near 105.0. Yields on 10-year Treasuries are trading near 4.33%, after matching yesterday’s 16-year high of 4.37%. Yields on 2-year Treasuries are trading near 5.06%. Crude oil prices gave way to more profit taking today after reaching one-year highs on Tuesday in overbought conditions. The grain and oilseed markets saw follow-through buying on Tuesday’s strength following another week of declining crop ratings.
A rate hike today from the Federal Reserve would be a shock to the market. Fed fund futures trading this morning gives just 1% odds of a rate hike following the conclusion of today’s Fed meeting, while maintaining 29% odds of a rate hike at the November meeting. That won’t be the focus of traders. Instead, they’ll be focused on the forward guidance from the Fed that will shed light on the perceptions of central bankers of the health of the economy, and the impact thus far of their monetary tightening. Do they believe that recent data provides sufficient indication that tightening to this point has been sufficient to eventually bring inflation down to the 2% target, or will more need to be done? Traders will also be looking to the projections for indications on how long rates might be held at current levels before pivoting lower. I’ll also be listening for any mention of the string of labor strikes that we’re seeing unfold that both provide a drag for the economy, while also contributing to the ongoing wage inflation question. So, while this is expected to be a “quiet” meeting, there’s a lot at stake for setting the tone going forward.
I’ll also be watching for any mention of commodity inflation in today’s statement and corresponding press conference. Energy prices are excluded from the core inflation numbers monitored by the Federal Reserve, but they eventually make their way into nearly every aspect of the price structure of the economy. Consumers are most sensitive to rising gasoline prices, but higher petroleum costs go into freight, packaging, and even into wages. Crude oil prices pulled back this morning ahead of today’s Fed decision, but that comes after prices reached overbought conditions at fresh one-year highs at $93.74 per barrel yesterday. Tuesday’s strength also pushed prices through trendline resistance on the charts off the March and June 2022 highs on the continuation charts, before settling back below that resistance at the end of the session, triggering profit taking by speculators in the market, providing the short-term direction. Longer-term, the market continues to be concerned about tighter supplies following cutbacks by OPEC+, and the difficulty of the North American market to increase output in the current political environment. High prices do increase investment, but it generally takes higher prices to do so when the political environment is so negative toward fossil fuels.
Meanwhile, longer-term Treasury yields continue to trend higher, with yields on 10-year Treasuries setting fresh 16-year highs on Tuesday, which they matched again earlier in today’s session before pulling back. The Federal Reserve controls the short-term rate structure, but it can only try to influence the longer-term rates. Congress continues to spend, increasing the supply of debt securities offered to the market. The Federal Reserve is decreasing its demand for those debt certificates by $1.14 trillion per year as it shrinks its balance sheet to reduce the monetary stimulus injected during the pandemic. Japan and China are the largest foreign holders of U.S. debt certificates, and they are also both reducing their demand for U.S. debt certificates for various reasons. In fact, China cut its ownership of U.S. debt certificates by another $13.6 billion in July in the latest data available, bringing its current holdings to 14-year lows after offloading $191.4 billion over the previous 16 months, while Japan reduced its holdings by $116.5 billion during the period. The increased supply of debt certificates creates a need to increase demand for them at a time when the previous major buyers are reducing their ownership. The primary way to bring supply and demand into balance is to increase the yields on those debt certificates, leading to higher interest rates. This is another way that Congressional spending leads to increased interest rates, providing a drag to the economy, while contributing to inflation.
Harvest continues to gain momentum in the Midwest, revealing a mixture of results across the region. Once again, the best results relative to normal are in the east, with the more disappointing results being in the western areas. My bias is that we’ll see USDA cut yields again in October due to smaller seed size this year, based on my agronomy background. I want to be fully transparent about my bias. That said, the early harvest results certainly support such, with more disappointing yields being reported thus far than strong yield results. But I also caution that early harvest results can be misleading in regard to the overall crop, and few farmers boast about record yields. So, while my bias is that USDA corn and soybean yields will decline going forward, I don’t think that we can depend on early harvest results to prove the case. I’ll have greater confidence in that once we see another 20 or 30% of the crops harvested.
