Each economic data point packs greater potency when investors fixate on Federal Reserve policy. Complicate the Fed watch with the added volatility that can come with “quadruple witching” contract expiration, plus a credit review for Puerto Rico, and we’re talking about one of the most important trading weeks of the year.
Fed members pull up around the conference table Tuesday and Wednesday. Uncertainty has been building ahead of Wednesday afternoon’s statement and post-meeting briefing by Fed Chairman Ben Bernanke, which could hold clues about monetary policy for the coming months. The Fed has been purchasing $85 billion in securities monthly to help stimulate the economy and the stock market has responded with repeated record highs—at least until hitting a few snags in recent sessions. Now that employment, retail sales, and manufacturing data have improved, the prevailing view is that officials will begin to scale back or “taper” bond buying presumably as the economy no longer needs this Fed crutch.
A Wall Street Journal survey of 46 industry economists shows that more than half expect the Fed to announce plans this week for a reduction in the pace of bond purchases beginning at the end of January. As Fed demand pulls out of the bond market, prices will fall and yields will rise. Market sentiment is likely to shift because rising interest costs could hurt business expansion, and accordingly, stock prices. Of course, longer-term, encouraging economic data is typically a positive for the equity market because economic strength tends to boost corporate profitability.
Budget Pact is Bad News. What?
Think this market’s not Fed obsessed? Recall last week when stocks fell sharply despite news that lawmakers had reached a budget deal. Some considered those developments stock-negative because Capitol Hill progress could increase the odds of aggressive Fed tapering. When central bank officials met in September, they noted that the impact from an ongoing budget deadlock was one reason for not reducing stimulus then. Consequently, as the odds for at least a preliminary budget deal rose last week, so did investor anxiety levels; the CBOE Volatility Index (VIX), the market’s “fear gauge,” hit a two-month high of 16 last Thursday (figure 1).
Figure 1: One-year CBOE Volatility Index (VIX) through Thursday, December 12, charted on TD Ameritrade’s thinkorswim® platform. Data source: CBOE. For illustrative purposes only. Past performance does not guarantee future results.
Under Review
There may be more to muddy the interest-rate picture. Moody’s put Puerto Rico on review for a potential credit downgrade to “junk” status because of swelling pension funding obligations and chronic budget deficits.
You may be thinking, well that’s too bad, but does it really matter to U.S. investors? Yep. Many U.S.-based funds hold the commonwealth’s debt. Loss of investment-grade ratings could lead to a mass liquidation that could ripple through U.S. bond and stock markets.
Witching Hour
There’s more. This week brings “quadruple witching,” which occurs when stock index futures, stock index options, stock options, and single-stock futures all expire, often leading to increased volume and increased volatility, especially intraday. The last day to trade standard options contracts is the third Friday of each month. Once every quarter—on the third Friday of March, June, September, and December—all four asset classes expire on the same day. Because futures and options investors must close out of their positions, volume is typically juiced.
Far-Sighted
Scanning the schedule shows data on housing starts and building permits due Wednesday morning, while Thursday offers jobless benefit claims and a regional manufacturing snapshot. Revised Q3 GDP numbers hit Friday. You can view the week’s lineup in figure 2.
The earnings calendar is fairly light and back-loaded.
One of these days, when the intense pressure of timing a major interest-rate policy shift has eased a little, the Fed and financial markets might actually start to care less about what’s directly in front of them and care more about what the data and earnings projections say about the longer-term health of the economy and the stock market. Will the luxury of an extended perspective start this week? Probably not.
Good trading,
JJ
TD Ameritrade, Inc., member FINRA/SIPC/NFA.
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Figure 2: Weekly U.S. economic report calendar. Source: Briefing.com.
