Oil Takes Center Stage As Fed Meeting Begins, With Light Volume Expected

Let the fun begin. Or is it, let the Fed begin?

Indeed, today marks the start of another Fed meeting, and pretty much the entire world seems to expect a rate hike. If it happens, it would be the second in the last 11 years, and the stock market looks strong as the decision approaches. 

Volume was a little lighter than normal yesterday, and it wouldn’t be surprising to see light volume once again today ahead of the Fed’s announcement Wednesday afternoon. Until the words are actually out of Fed Chair Janet Yellen’s mouth, investors may project caution.

So with the stock market perhaps not as vibrant today, the big story is crude oil. Crude prices climbed again early Tuesday, rising above $53 a barrel and reaching the highest levels since mid-2015. Oil prices had also climbed sharply early Monday, giving energy sector shares a big boost. But as the day went by, the futures market retreated, and energy stocks only ended up climbing 0.7%. There’s some trepidation that the agreements by OPEC and non-OPEC producers to reduce crude production could light a fire under U.S. producers (see below).

Oil is up nearly 20% over the last month, while major stock indices have galloped to new all-time highs. Needless to say, a lot of factors play into the current stock market rally, but strength in oil, which can sometimes imply strength in the underlying economy, is certainly one of them. The question is whether U.S. crude futures can push through the $55 level, which proved a barrier last time they approached this area back in June.

Counter-cyclical sectors, including telecom services and utilities, ended up leading the market on Monday, with some of last week’s big gainers falling back. Financials, industrials, materials, and consumer discretionary names helped spark the month-long rally, but all fell on Monday.

Even as some big-name stocks fell back on Monday, 10-year Treasury yields zoomed up above 2.5% for part of Monday’s session, the highest they’ve been in more than two years. How much further can the yield go up? According to one analyst, current yields may already have anticipated much of the Fed’s projected interest rate policy over the next year (see below).

What Next for Fed?

Futures markets peg odds for a Fed rate hike Wednesday at 95%, meaning there’s not much drama going into the Fed’s meeting. But then what? Not too much, at least until mid-2017, if the futures market ends up being accurate. The first time there’s a 50% chance or better of another hike isn’t until June, according to CME Fed funds futures. But by Q4, the Fed funds target midpoint could rise to a mid-point of around 1.13%, said Sam Stovall, Chief Investment Strategist at CFRA. Stovall also noted that the 10-year Treasury yield has already anticipated much of that move and is projected to average 2.45% in Q4 of next year, or about where it is now. Stovall’s other 2017 predictions? “Subdued” inflation, and oil prices averaging in the low $50s. 

OPEC Speaks, and U.S. Producers Take Note

As OPEC and non-OPEC oil producers discussed ways to trim crude output and nearby crude futures rose to 17-month highs, U.S. oil producers weren’t taking an early holiday. The number of active U.S. oil rigs rose by 21 to 498 last week, the highest level since January, according to Baker Hughes. U.S. oil production has fallen significantly since the highs of two years ago, and it’s conceivable that U.S. producers could get those barrels back into supply relatively quickly if oil prices remain above $50 a barrel. The last time OPEC cut production, in 2008, U.S. oil production skyrocketed from an average of 5 million barrels a day that year to more than 9 million barrels a day by 2015, according to the U.S. Energy Information Administration (EIA).

The “Almighty” Dollar

That was the cover of The Economist this week, and it seems well chosen. The dollar continues its march against other currencies and remains at its highest level since the early 2000s. The anticipated Fed rate rise would certainly seem to have a chance of adding fuel to the fire, but don’t discount the possibility of a “buy the rumor, sell the news” scenario for the currency.