Daily Market Reports | Feb 07 2008
By Greg Peel
After one of the uglier sessions in recent history yesterday, Wall Street was poised to pull some back from the outset. Impetus came from a strong result from Dow component Disney, which “beat the Street” thanks to the success of its Hannah Montana franchise (ask your kids). Disney shares jumped 5%. The Dow rallied 125 points.
But that’s where it ended. Philadelphia Fed president Charles Plosser then came out and warned that inflation was a problem that could not be ignored. His comments ran largely in contradiction to the statement accompanying the Fed’s last 50 point cut in which, for the first time in ages, the Fed said inflation would moderate.
To ignore inflation in times of economic weakness “risks undermining our ability to achieve economic growth over the long run,” said Plosser. This was in response to those who suggest inflation should simply be ignored when economic weakness is the ogre. He also countered suggestions that a slower economy would also slow inflation growth, pointing at the 1970s experience of slow growth, high unemployment and high inflation.
He also suggested that aggressive rate cutting will not solve all the current financial woes overnight. It cannot solve the bad debt mortgage problem, nor CDOs, nor ratings downgrades. These must be ultimately solved by the market, and that will take time.
This was not what Wall Street wanted to hear. The implication is that the Fed may not necessarily make further rate cuts as expected. The Dow turned around, and by the end of the session was down 65 points, or 0.5%. The Disney result acted as a dampener on the Dow, as the S&P fell 0.8% and the Nasdaq 1.3%.
But what was even more unsettling for traders was the following comment from Plosser:
“Fortunately, so far inflation expectations have not changed very much. But they bear watching because there are some signs that they too are edging higher. These may be early-warning signs of a weakening of our credibility, and we must be very careful to avoid that.”
Everyone in the market has questioned the Fed’s supposedly slow responses, and thus credibility, from Day One of the credit crunch. Except, that is, the Fed itself. If the Fed is now questioning its own credibility, what hope for the rest of the market? This was not well received.
Adding to weakness along with Plosser’s comments was an announcement that department store giant Macy’s would begin consolidating stores and laying off 2,300 middle managers. This followed its January sales result, which was particularly poor. Macy’s shares dropped 5%.
There was another fall in the price of oil last night – US$1.27 to US$87.14/bbl – following the release of the inventory figures. Inventories of crude, gas and heating oil have all risen considerably as the US has not suffered a particularly bad winter to date. These numbers seem to have the ability to spin on a dime, so don’t get too excited, and the next blizzard may only be around the corner. But all this recession talk should encourage the oil price lower. Plosser, for what it’s worth, said he expected the US economy to slow, but not recede.
The US dollar continued its rise against the euro last night, buoyed by the possibility that another rate cut is not a given, although it fell against the yen, just to confuse the issue. The Aussie marked time in the push-pull. Gold, however, looked like a good investment again, particularly if the Fed is talking inflation concerns. It rallied back $11.70 after its tumble on Tuesday to US$899.60/oz.
Inflation talk also pushed ten-year bond yields up, but there was no change to views in the Fed funds futures market. This market is still predicting a rate cut in February, and given there is no scheduled Fed meeting in February, it would have to be an emergency cut. No inflation scares there.
There was a slight bounce back in metal prices in London, mostly because they closed when the Dow was up. There are also option contracts expiring this week, so there is some positioning going on. Chinese New Year is still keeping the market thin, however.
The SPI Overnight was up 10 points.
Xin Nian Kuai Le. Gong Xi Fa Cai.
