Wednesday, October 30, 2013 - Fed Holds Steady and Floats a Balloon

Fed Holds Steady and Floats a Balloon

by Sinclair Noe

DOW – 61 = 15,618
SPX – 8 = 1763
NAS – 21 = 3930
10 YR YLD + .02 = 2.52%
OIL - .85 = 97.35
GOLD – 1.40 = 1343.90
SILV + .22 = 22.84

Nobody expected the Fed to make any major policy changes at the conclusion of today's 2-day FOMC meeting. And the Fed surprised no one as they kept their cheap money policy in place. So why are the markets down today, with the Fed continuing its easy money giveaway? I'll explain in a moment.

Language in the October statement mirrored the "moderate pace" of economic improvement that the Fed saw at its last meeting in September. The statement, though, did omit a reference from last month that fiscal tightening could slow growth in jobs and the broader economy. Let's dig into the Fed statement:

...economic activity has continued to expand at a moderate pace. Indicators of labor market conditions have shown some further improvement, but the unemployment rate remains elevated. Available data suggest that household spending and business fixed investment advanced, while the recovery in the housing sector slowed somewhat in recent months. Fiscal policy is restraining economic growth. Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

...economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall.

...Taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.

And so, the Fed will continue buying $45 billion a month in Treasuries and $40 billion a month in mortgage backed securities, and they will maintain their zero interest rate policy, but they seemed to be making the case that when they can get a little more data, the data will be good and they can taper. Maybe even in December. How do we know?

Because John Hilsenrath said so. Hilsenrath is a reporter with the Murdoch Street Journal and he's something of a mouthpiece for the Fed. He gets the Fed data before other reporters and he then reports what the Fed tells him to report. Within 15 minutes of the Fed statement, Hilsenrath had published two articles analyzing the statement. He is either the fastest typist in the world or he gets the information spoon fed ahead of the embargo. The key takeaways according to Hilsenrath:

The Fed dropped its reference to financial conditions having tightened in recent months, as it noted in September. That’s a nod of approval to rising stock prices and the recent drop in long-term interest rates. The Fed also removed a reference to its concern about higher mortgage rates, which have dropped since the last meeting.

The Fed retained language it used in September which suggested officials had an eye on pulling back from their bond buying program if the economy improved. It noted “underlying strength” in the broader economy and said it chose to “await more evidence” on the economy’s performance before adjusting the bond-buying program.

And then the kicker:

Taken together, the Fed isn’t taking a December adjustment to the bond-buying program off the table. But that comes with the strong caveat that it depends on whether the economy is living up to its expectations.

Citigroup then piled on by raising it's odds for a December/January taper. It's pretty simple really; the further down the path we go, the closer we get to the end. The Fed hopes there will be enough economic data to support a taper, even though we've gone through 5 years of this mess with anemic growth and little to indicate the economy will kick into high gear. And the Fed's nearly $4 billion in bond buying seems to have only produced an artificial and temporary boost for stock and bond prices. It's impossible to predict where prices will go when the Fed stops buying because we're dealing with an artificial construct, but the bet is that prices might move lower.

Of course, we've seen this before. The Fed floated the trial balloon on tapering, and the markets responded with a taper tantrum; and it is a good bet that is what we are seeing today; just enough taper worry to back off record highs and slow the parabolic rise on the charts; the Fed tapping on the brakes without changing gears.

The January FOMC meeting will be the last for Chairman Ben Bernanke, who is stepping down after eight years. President Barack Obama has chosen Vice Chair Janet Yellen to succeed Bernanke. Assuming that Yellen is confirmed by the Senate, her first meeting as chairman will be in March. Many economists think no major policy changes will occur before a new chairman takes over.

Congress' budget fight has clouded the Fed's timetable. Though the government reopened Oct. 17 and a threatened default on its debt was averted, Congress adopted only temporary fixes. More deadlines and possible economic disruptions lie ahead in December and January and February. So, there is a strong probability that any data the Fed considers will be distorted by fiscal policy or the lack of fiscal policy.

At some point, the Fed will taper, but they are also caught in a liquidity trap. You could make the case that the early rounds of QE contributed to a bounce in economic activity, but you could also argue that there is almost always a surge in economic growth following post recession weakness due to pent-up demand. Plus, in the early rounds of QE there were actually several more direct bailouts, including cash for clunkers, cash for casas, and even cash for refrigerators and toasters and other appliances. Maybe the Feds massive injections of cash have helped to keep the economy from slipping backward, but current indicators are showing signs of weakness.

Consumer and business confidence has been hammered by the political fight that triggered the government shutdown and pushed the nation to the brink of a nasty debt default, and a slew of recent data has pointed to economic weakness.

Economic reports today showed private sector employers hired the fewest number of workers in six months in October, although we'll wait until November 8^th for the monthly jobs report. ADP revised September’s job gain down from 166,000 to 145,000. The government shutdown and debt limit brinksmanship hurt the already softening job market in October. Average monthly growth has fallen below 150,000. Any further weakening would signal rising unemployment. Meanwhile, inflation stayed under wraps last month. Other data on hiring, factory output and home sales in September had already suggested the economy lost a step even before the government shut down. Readings on consumer confidence this month have shown the fiscal standoff rattled households right as we head into the holiday shopping season.

In trading following the market's close, Facebook gained almost 10% after reporting revenue that was stronger than expected. Expedia gained almost 20% after reporting its results. On the downside, Starbucks shares fell 2.8 percent to $78.60 after the bell because the world's biggest coffee chain gave a 2014 profit outlook that was below expectations.

In the latest batch of earnings, General Motors reported stronger-than-expected quarterly profit because of strength in its core North American market and a smaller-than-anticipated loss in Europe. GM shares moved higher.

On the downside, Yelp dropped after it reported a wider third-quarter loss, while Western Union shares slid 12.4 percent to $16.85 after the company posted a steep drop in third-quarter earnings.

Earnings haven't been amazing, but they've been steady and sustainable, which the market likes enough to help us reach all-time highs. When the season ends and we focus on the macro again, that probably won't be good for the market.

Of the 313 companies in the S&P 500 that had reported earnings through Wednesday morning, 68 percent have topped Wall Street's expectations, above both the 63 percent beat rate since 1994 and the 66 percent rate for the past four quarters. Revenue performance has been mixed, however, with 53 percent of S&P 500 companies beating expectations, well below the 61 percent average since 2002, but slightly above the 49 percent rate for the last four quarters.

Tomorrow morning the Labor Department will release jobless claims for the past week. Due to recent computer upgrades in California, claims data has been distorted higher and should continue to trend back to an average of 335,000. Also due out are the regional Chicago and Milwaukee manufacturing surveys.

There will be a lot of economic data released tomorrow around the world. The Bank of Japan will make its monthly monetary policy statement, which is expected to turn a bit more dovish due to a slower rate of growth in inflation and employment. Fifty-three major US companies will report earnings tomorrow.

The rest of the world is still upset with the US for listening in on their phone calls. Responding to the firestorm of controversy over its spying on European allies, the head of the National Security Agency said today it would do everything in its power to avoid being caught doing it in the future. And I hope you've had a great day; if however it was a little less than you had hoped for, take consolation in the fact that you are not Kathleen Sebelius.

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