Book’em, Danno. It’s time for a vacation.
A batch of reports out yesterday, followed by the FOMC meeting’s communiqué, may have opened the doors for investors to book the profits they have made over the past 6 months and start making plans for a nice mid-year vacation.
After 2 weeks of gains from mostly positive Q1 earnings reports, the major indices looked a little tired early yesterday morning, starting the day on the slide even before the reports came out. By the time the FOMC’s communiqué came out at 2 pm eastern, the Dow Jones Industrial Average was down some 120 points, or 0.8%.
While the Federal Reserve’s statement did lift the markets a little, they quickly gave it all back within an hour, with the Dow closing the day down some 138 points, or 0.94%, the S&P 500 closing down 0.93%, and the NASDAQ down 0.89%.
That final push down after the Fed’s statement does not sit right with many investors. More profit taking and defensive repositioning is expected.
Economic Reports Disappoint
First up yesterday was a disappointing ADP employment report showing 119,000 private-sector jobs were created in April, much lower than the 150,000 expected, and lower than the previous month’s 131,000. This casts an ominous shadow on this Friday’s jobs report, which might spook investors and trigger more selling.
Then came a disappointing Institute for Supply Management index (ISM) at 50.7%, which, although still expansionary at over 50%, was lower than March’s 51.3%. Though the new-orders component of the ISM rose to 52.3% from the previous 51.4%, and the production component rose to 53.5% from the previous 52.2%, it was the employment indicator’s drop to 50.2%—the lowest since November—which dragged the ISM down. Another shadow looming over Friday’s jobs numbers.
The markets were dealt another blow yesterday by the construction spending report for March, which showed a reduction of 1.7% where the market was expecting an increase of 0.7%. Although residential housing construction did increase by 0.7% in March, commercial construction dropped by 2.9%.
The April vehicle sales report also came in at slightly below expected readings, reporting 11.9 million domestic sales compared to the 12 million expected, and 14.9 million total sales compared to 15.3 million expected, both slightly weaker than March’s.
FOMC Report Pacifies
It was now up to the Federal Reserve to step up to the plate and hit one home for the crowd. And it gave the markets pretty much all they had expected.
Highlights from the FOMC’s statement include the promise to “continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month” with the aim of “maintain[ing] downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.”
So, yes, they are going to keep pumping money into the economy and keep interest rates down. And they will do so “at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.”
All 3 requisites currently show green lights for the Fed to keep its foot on the accelerator.
But yesterday’s statement did come with a little bit of an unexpected addition: “fiscal policy is restraining economic growth”, it indicated.
This sounds rather bizarre. It seems to indicate that the Federal Reserve is struggling against other policies the government has in place, conveying the idea that the FOMC may need to do more.
And then it came: a second addition even more unexpected than the first, one which the Fed had not included in its statements before:
“The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.”
The Fed is keeping itself open to “increase” as well as reduce its purchases as economic conditions necessitate. As MarketWatch pointed out, “Fed Chairman Ben Bernanke had previously said the Fed was flexible, but this is the first time it was included in the statement.”
It made Pantheon Macroeconomic Advisors chief economist Ian Shepherdson raise an eyebrow, stating that “the new flexible language matters”. While many economists over the past few months have been talking about when the Fed’s asset purchases would be reduced or even terminated, here the Fed is reminding everyone that they still reserve the option to increase them.
“It is a clear reminder that the hawks aren’t the only ones with strong views,” MarketWatch quotes Shepherdson.
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More Stimulus to Come?
The Fed’s new openness to even further stimulus together with weaker reports earlier in the day and earlier in this quarter raise some concerns over the state of the U.S. economic recovery.
It all seems to be “reflecting the reality that a strong winter has once again yielded to a disappointing spring,” the New York Times concludes, adding, “Some [analysts] saw it as a signal that the Fed’s next move could be an expansion of its stimulus.”
Worries are growing that the recent 20% rise in U.S. stock markets in just 6 months is overdone, given that it has come with minimal job growth. You can’t have real growth in the economy without real growth in jobs.
Is this more open-minded wording of the Fed’s statement telling us that the economic recovery might need more financial help?
Jim O’Sullivan, chief U.S. economist at High Frequency Economics, doubts it. “I don’t think there’s much chance of them stepping it up,” he informed MarketWatch. “But this is certainly their way of saying there’s no bias toward scaling down.”
Michael Feroli, chief United States economist at JPMorgan Chase, wrote in a note to clients, “In effect, the Fed signalled that the pace of asset purchases would be data dependent in both directions, but that right now the data gives them little reason to change in either direction,” MarketWatch cites.
What the FOMC statement does make predictably clear is that it will keep watching and monitoring as reports come in, and it will keep itself flexible enough to move either way.
“In determining how long to maintain a highly accommodative stance of monetary policy,” the statement explains, “the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.”
All we know at this point in time is that the accelerator is down, with the option of it going down even further if the economic recovery needs it.
As for the markets, this Friday’s 8:30 am eastern jobs numbers may have this summer’s fate spelled out within its pages.
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