The announcement on Saturday of an agreement to eliminate Syria’s chemical weapons stockpile sharply reduces the likelihood of a U.S. military strike, and its unknown consequences, at least for the time being. Compliance with the terms of the agreement is now the issue, and if Syria acts in bad faith, a military strike is still a possibility. But investors, who have been heartened by the possibility of a diplomatic breakthrough, will now be able to breathe a further sigh of relief.
Stock markets in the Middle East, the source of 35% of global oil production, rallied on the news on Sunday, with Israeli stocks up 1.9%, Saudi Arabia up 1.8%, Qatar up 1.7% and Dubai up 4.8 %. Brent crude oil had already pulled back last week in response to the prospects for a negotiated agreement over the Syrian crisis. After closing at price per barrel of $114.42 on Sept. 6, crude oil ended last week at $111.70, down 2.4%. The price had been trading closer to $109.50 before spiking on Aug. 27 and the days following, when the U.S. appeared close to launching a strike, suggesting an additional decline back toward that level is likely, as the risk premium recedes.
The Long-Awaited Fed Meeting
Of course, Syria is not the only issue on investors’ minds this week. The Federal Reserve convenes a two-day meeting on Tuesday, and is widely expected to announce the commencement of the tapering of its quantitative easing program on Wednesday.
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That it will do so is not a certainty, however. It could choose to wait, especially after the somewhat disappointing August jobs report.
No announcement would likely be met with relief, pushing both stock and bond prices higher. But if the commencement of tapering is announced, the likely reaction is less clear.
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In the long run, tapering should be viewed as a welcome acknowledgement that the economy has recovered enough, and has enough traction, to continue to grow with less monetary stimulus. But in the short run, there will be the realization that Fed policy is beginning to change. And, although less stimulus may not be a tightening per se, and policy accommodation will remain robust, this tailwind for capital markets will diminish somewhat.
It remains to be seen whether this causes a selloff, whenever it happens. Certainly, the expectation of tapering has had more than enough time to have been discounted by markets. Arguably, this can more readily be seen in bond prices than in stocks. The yield on the ten-year Treasury note has climbed from 1.60 to 2.90 since the idea of tapering was first introduced in May. Stocks, on the other hand, are 7% higher. But bonds are more directly impacted by the Fed’s program, since, after all, quantitative easing is a bond-buying program. So, the diminution of activity from the market’s biggest buyer of Treasury and mortgage bonds may yet have an additional impact.
Congress Refocuses on Budget Deal
The agreement on Syria will allow Congress to focus on its other business, something it was unable to do last week. The 2014 federal fiscal year begins in just two weeks, and as usual, no budget is in place. That means a continuing resolution will have to be passed to keep the doors open. Treasury has said that the debt ceiling will be reached in mid-October, so there is a chance that any continuing resolution would include a temporary increase in the debt ceiling in order to buy time to agree on a budget. The process will likely be contentious. Until the possibility of default is removed with a longer-term increase in the debt ceiling, this issue will remain a distraction for markets.
Other Developments
There are also plenty of economic reports on the calendar this week to provide an opportunity to focus on fundamentals, not just policy. August industrial production and capacity utilization, and September New York regional manufacturing conditions start things off on Monday. Each is expected to show improvement from the prior month. August consumer prices, the September Philadelphia regional manufacturing report, and leading indicators follow. There is also a host of data concerning the housing sector, starting with the National Association of Home Builders index. After falling throughout the first third of the year, the index has risen steadily since. Nevertheless, the September report is expected to show a modest decline. August housing starts and building permits are expected to have improved from July, but existing home sales look to have slowed.
But this week will be all about the Fed. What it says and how markets respond will be the story.
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