Stock Week Ahead: Oil Stains the Backdrop for Deliberating Fed

Major stock indexes logged a weekly loss last week, their first in a month, plagued by weakness for energy and materials shares at a time when few industry economists believe the drop for oil prices is over. It’s a messy backdrop for this week’s deliberating Federal Reserve and for a stock market that’s trying to stay a step or two ahead of interest rate moves.

Driven by high supplies and slowing global demand, crude oil settled under $37 a barrel at one point last week for the first time since 2009. Commodities prices are falling in step with oil weakness and pose a challenge to global economic growth just when the Fed has said it wants to return the U.S. economy to “normal,” or free from recession-era, ultra-easy monetary policy. In other words, the bulk of Fed members have expressed their inclination for higher interest rates when much of the rest of the world is holding pat or favoring easier interest rate policy. This disconnect itself could keep up the pressure on the dollar, commodities, and stocks.

All Eyes on the Fed
The Fed is expected to shed some light on its thinking with a two-day policy meeting this week. They huddle on December 15-16 to be exact, with a release expected around 2 p.m. Eastern Wednesday. In the few days before that meeting conclusion, data on consumer inflation and housing (see the full economic calendar below) could help speculative traders guess at impending Fed action (or inaction?). At last check, short-term Fed funds futures market traders have priced in an 81% chance that the Fed activates the first interest rate hike since 2006 this week, according to pricing calculations provided on the CME Group’s FedWatch Tool.

From there, traders are likely trying to speculate on how aggressively the Fed could move in its pledged efforts to return policy to “normal.” The Fed isn’t getting much help for its case for higher borrowing costs from market interest rates, which in the short term are working against the Fed’s policy bias; the yield on a benchmark 10-year Treasury fell to 2.16% on Friday as the commodity sell-off sent some traders scurrying into the perceived safety of government-backed bonds.

Other Factors
The looming Fed session likely helps explain the stock market’s particular sensitivity to falling commodities prices over few other drivers, including domestic economic data and big deal news. Wall Street nerves appear to be elevated heading into mid-month as this week includes the potential added volatility of “quadruple witching”—the expiration of futures and futures options on top of stock and index options.

Wall Street’s attention is also focused on Washington, where lawmakers are rushing to finalize a $1.1 trillion government-wide spending bill and a beefy tax package touching all sectors of the economy, then head home for the holidays, the AP and other news outlets report. Congress has needed a couple extensions already to get the work done.

Select stock sectors could be impacted as Republicans are seeking to lift the oil export ban and roll back various Obama administration regulations; Democrats aim to protect Obama's environmental rules and enact permanent tax credits for wind, solar, and other renewable energy, among other issues.

Also of note, the NASDAQ Composite (COMP), loaded with tech shares, fell below the psychologically notable 5,000 line last week. The broader S&P 500 (SPX) logged weakness across most of its sectors, but a nearly 3% drop on Friday alone for its energy sector proved to be a drag on the whole index. In other words, plenty of stock movement has precluded the Fed’s decision. That’s not likely to abate leading right up to this potentially important interest rate meeting and in its immediate aftermath.