Market Outlook: Why Fed Is Likely to Remain on Hold

Market Outlook: Why Fed Is Likely to Remain on Hold

Postby DDEATH » Sat Mar 10, 2012 9:41 am

Market Outlook: Why Fed Is Likely to Remain on Hold

The Federal Reserve meets in the coming week against the backdrop of an improving employment picture, making further monetary easing less likely for now.

The February employment report Friday showed a better-than-expected 227,000 nonfarm payrolls were created, and revisions showed another 60,000 workers were added in December and January.

“It’s enough to sustain the economic momentum and keep the Fed on the sidelines … I think the market is now waiting for the next thing,” said Jeffrey Kleintop, chief market strategist at LPL Financial.

The Fed will probably keep the door open to more easing, but it is not expected to advance the idea. Fed Chairman Ben Bernanke, in Congressional testimony earlier this month, suggested the Fed does not, for now, have to do a third round of quantitative easing, or purchase securities in an effort to drive down interest rates. The Fed had put that option on the table, and before Bernanke spoke, some market participants had expected the Fed to act sooner rather than later.

“I think [the jobs report] was unambiguously good,” said Mark Zandi, chief economist at Moody’s “A lot of the details in the report were solid. I guess the only exception would be the small increase in wages. Barring that, everything looked really solid and all the leading indicators were positive. Take that in the context of the last several months, and something fundamental is going on here. Businesses are finally increasing their hiring …I don’t see how the Fed can move. There’s nothing in the jobs data that suggests they need to ease further at this point.”

Besides the Fed’s Tuesday meeting, market focus will be on a flood of February economic readings, including retail sales, inflation, consumer sentiment and industrial production. Also important will be weekly jobless claims, which rose slightly in the past week. The markets will also be waiting to see if there are any unexpected aftershocks from Greece’s private sector debt restructuring.

Zandi said he will be watching retail sales to see if the employment situation is helping spending. “That’s been on the soft side of expectations for the last couple of months. I’m hopeful we get a better number,” he said, adding he expects to see 0.4 or 0.5 percent.

He said the jobs data did get a lift from hiring related to the warm winter, and payrolls could weaken later in the spring. “Gasoline prices are doing some damage. We’ll be below 200,000 sometime this spring but the underlying job market is improving,” he said. The national average for gasoline Friday was $3.75 per gallon, up from $3.48 a month ago.

Markets will also be watching the consumer price index . While the Fed favors the PCE inflation measure, CPI should show some impact from rising gasoline prices when it is reported Friday. Inflation above the Fed’s targeted 2 percent by its measure, would keep easing off the table, and the CPI could give hints of that.

“I don’t think they can or will totally backtrack or take QE off the table,” Zandi said. “I think it’s premature for that , but I don’t think they move with these kinds of numbers. If I were them, given the balance of risks, I would continue to keep that in my tool kit.”

Whither Stocks?

Kleintop said the market will fixate on the Fed and data this week, and the economic news could at some point start to disappoint after a run of positives. “The data has surprised for a long time, and people are now coming around to the idea that the economy is going to limp along at 2 percent or so and not slip into recession. I think that the market has priced that in and is now wondering what the next thing is going to be: Portugal? or the election here? our fiscal outlook?” or the loss of earnings momentum, Kleintop said.

“It’s a market waiting for something. I think if we look out over the next several weeks, I see more negatives than positives,” said Kleintop. Analysts have been expecting a pull back since the major market indices broke through their 2011 highs in the last several weeks but the market this year has had just one big down draft, on Tuesday of this past week. The S&P 500 [.SPX 1370.87 4.96 (+0.36%) ] is up 28 percent since its October low, and as of Friday, the third anniversary of the start of the bull market, the S&P is up 102 percent.

Stocks in the past week were more volatile than they’ve been so far this year. They finished the week mixed after a mid-week plunge. The Dow [.DJIA 12922.02 14.08 (+0.11%) ] posted a weekly decline, while the S&P and Nasdaq logged gains for a fourth consecutive week.

Treasury yields, meanwhile, rose as the Greek private sector debt swap attracted high participation, putting Greece on the path to an orderly default. The 10-year was yielding more than 2.04 percent Friday. The dollar also rose on both the Greek deal and the prospect that a better U.S. economy would mean less Fed action.

“I think it leaves the euro in flux. There’s little enthusiasm for the euro here. The really critical thing here is that the clue comes from dollar/yen. What today’s [jobs] number really signaled was the Fed cannot under any circumstances consider QE3 even in a sterilized fashion. They don’t have much argument for it even if they want to,” said Boris Schlossberg of GFT Forex.

Schlossberg was referring to a Wall Street Journal article that said the Fed could consider a modified QE or “sterilized” bond purchases at its next meeting, where it would buy Treasurys or mortgages but tie up the money by borrowing it back for short periods at low rates instead of just ballooning its balance sheet. But there is little expectation the Fed would announce such a move.

“If we see 10-year yields get to 2.10 percent that really produces a very strong support for dollar/yen,” he said. The dollar hit a 10-month high against the yen Friday and was trading at 82.48 in the afternoon. Besides the data, the Treasury auctions $32 billion 3-year notes Monday; $21 billion 10-year notes Tuesday, and $13 billion 30-year bonds Wednesday.

What Next Europe?

Greece’s debt swap Friday triggered a credit event that would result in default. It was expected to trigger about $3.2 billion credit default swaps, a much smaller than expected amount.

“The markets have been hostage to this Greek story, and the biggest fear all along was for a disorderly default,” said Goncalves. With the debt swap and ECB and IMF programs for Greece, “it takes away those really negative tail risks of a contagion leading to a breakdown of the whole euro zone. It shows that when things really get down to the final hour, they do come together.”

“Greece was really the one that was the lynchpin that could have set in motion a much more dire outcome so this should be viewed in a positive light. It also tells you those other countries remain under stress in terms of their fiscal problems, but when push comes to shove the European policy makers are handling these problems,” said Goncalves.
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