Will the Fed Follow the Bank of England?

Talk about good luck—I was coincidentally in London, just as the Bank of England created a stir in the financial world! Last Thursday, Bank of England Governor Mark Carney said interest rates in the U.K. could rise sooner than investors expect. The statement was the clearest evidence that Britain’s five-year period of record-low borrowing costs is drawing to a close, perhaps portending the same for other central banks. While the British economy is in a different situation than its former colony across the pond, (parts of the empire are facing skyrocketing property prices), investors immediately extrapolated the British position and applied it to future Federal Reserve action. The analysts’ at Capital Economics note that eventually, “central banks may correctly decide that economies no longer need the support from ultra-loose monetary policy or that the benefits no longer justify the costs and risks. This point may still be a few years off, but we suspect that US interest rates in particular might return towards more normal levels at a faster pace than currently anticipated.”

This Wednesday, the Federal Reserve convenes its two-day policy meeting, where it is expected that officials will announce another $10 billion cut to their bond-buying program, reducing monthly purchases to $35 billion. Since the financial crisis, the Fed has bought more than $3 trillion worth of government and mortgage backed bonds, in an effort to inject money into the banking system; to lower long-term interest rates; and to stimulate overall economic activity. Eventually, those securities will come off the Fed's balance sheet as they mature or the central bank sells them, but that process could take years.

The central bank is also expected to keep short-term interest rates near zero, where they have been since the height of the financial crisis in December 2008. This meeting will also feature Fed projections about economic growth, unemployment and the future course of rates. The day will conclude with the main event, a press conference with Chairman Janet Yellen, where some expect her to mention concern about investor complacency. As mentioned last week in this space, the VIX, a measure of expected stock-market fluctuations, has been below its long-run average for nearly a year and a half—that’s a string of steadiness not seen since 2006 and 2007, before the financial crisis and recession. Of course it goes without saying that extended periods of low volatility can themselves increase the chances of bad events occurring.

MARKETS: Stock indexes fell for the first time in a month and oil increased, as violence escalated in Iraq. Iraq is the world’s eighth-largest producer of oil and ranks number two in OPEC countries, behind Saudi Arabia. Iraqi production has been on the comeback trail since the height of the Iraq war, hitting 3.6 million barrels a day in February, its highest level in more than 30 years. Since then, it has since fallen to 3.3 million barrels a day in May. Any protracted events in Iraq could impact oil production and prices.

• DJIA: 16,775, down 0.9% on week, up 1.2% YTD
• S&P 500: 1949, down 0.7% on week, up 4.7% YTD
• NASDAQ: 4,321, down 0.2% on week, up 3.2% YTD
• 10-Year Treasury yield: 2.6% (from 2.58% a week ago)
• July Crude Oil: $106.91, up 4.1% on week
• August Gold: $1252.50, up 1.7% on week
• AAA Nat'l average price for gallon of regular Gas: $3.66 (from $3.63 a year ago)

THE WEEK AHEAD:

Mon 6/16:

International Monetary Fund releases its annual review of the U.S. economy

8:30 Empire State Manufacturing

9:15 Industrial Production

10:00 Housing Market Index

Tues 6/17:

Fed begins 2-day policy meeting

8:30 Housing Starts

8:30 Consumer Price Index

Weds 6/18:

2:00 FOMC decision and econ projections

2:30 Fed Chair Yellen Press conference

Amazon expected to unveil a new smartphone

Thurs 6/19:

8:30 Weekly Jobless Claims

10:00 Philadelphia Fed Survey

Fri 6/20:

Quadruple Witching: The expiration date of stock index futures, stock index options, stock options and single stock futures. Because investors must close out of their positions, there is often an increase in trading volume.