The Overnight Report: Awaiting The Fed

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 Greg Peel

The Dow rose 45 points or 0.4% while the S&P gained 0.6% to 1127 and the Nasdaq added 0.8%.

One might have expected Wall Street to square up by taking profits ahead of the much anticipated Fed monetary policy statement tonight, but it appears growing confidence of renewed Fed action was enough to keep traders in a buying mood. Good sales figures from McDonalds and some positive views in tech provided impetus, but the reality is volume was so low the session can almost be considered irrelevant.

Tonight the Fed is expected to tell us the US economic recovery is struggling. But last month the Fed described conditions as “unusually uncertain”, so one wonders just how much worse the situation could have become in the central bank's view. It was also last month that the Fed clarified that it was ready to take renewed action – to re-implement quantitative easing (QE2) – were the situation to become more dire.

Is it more dire? Wall Street seems to think so, because it has been quietly strong in its pre-emption of QE2. Last month the Fed outlined three measures it had at the ready and Wall Street is expecting an announcement one or two or all measures will now be put in place. They are: (1) reducing the interest rate paid by the Fed on mandatory bank deposits from the GFC- inspired level of 0.25% back to zero in order to encourage banks to stop parking excess cash with the Fed but to “put it to work” in the economy through lending; (2) to maintain mortgage security support by no longer allowing securities held by the Fed to mature un-replaced or to step up mortgage security purchases once more; (3) to put a more definitive time frame on the “extended period” for which the Fed intends to keep its cash rate at near zero.

The assumption is that while the Fed has its quiver loaded, no arrows will actually be fired unless it sees sufficient danger. Which thus implies a simple conundrum. How will Wall Street react tonight, either way? Two scenarios are possible.

The Fed could announce some form of QE2 and Wall Street could go for a run, seeing it as positive that the Fed is stepping in to prevent the feared “double-dip”. The Fed could announce that the measures are still at the ready but not yet needed, and Wall Street could tumble on fears all hope is now lost. Or…

The Fed could announce some form of QE2 and Wall Street could tumble on the basis that if the Fed is acting once more, the economy really is in bad shape. The Fed could announce that the measures are still at the ready but not yet needed, and Wall Street could go for a run, relieved to know that the Fed does not see the economy being in dire straits.

The former scenario is probably more likely, given that's the way Wall Street has worked ever since the GFC. But then again, maybe we'll just have a stalemate, whatever the outcome. The VIX volatility index is at 22, which is low enough to suggest no one's been loading up on protection just in case.

So we can debate the issue until we're blue in the face, or just wait for 2.15pm New York time tonight to see what actually happens.

In the meantime, the US dollar was arguing against the stock market by rising 0.4% last night on its index to 80.71, thus trimming the Aussie slightly to US$0.9165 and gold by US$4.50 to US$1201.20/oz. If QE2 is instigated, the US dollar should weaken.

After a few weak days oil rose US78c to US$81.48/bbl. Base metals were mixed, with most steady but nickel and tin going for a 3% run. The impetus here is the step up by Beijing to shut-down excess and aged smelting capacity in order to curb pollution.

The SPI Overnight gained 4 points.

One would assume the Australian market will also be quiet today, except for the fact we have our own economy to consider. NAB will release its monthly business conditions and sentiment survey today and we will have earnings results from Alumina Ltd ((AWC)), Bradken ((BKN)), Challenger Property ((CDI)), Cochlear ((COH)), Oakton ((OKN)) and Reckon ((RKN)), plus National Bank ((NAB)) will provide a quarterly update.

And China will report its monthly trade balance.

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