Daily Market Reports | May 01 2008
By Greg Peel
It was an exuberant mood on Wall Street early on rate decision day as good results were posted by Dow components General Motors and Proctor & Gamble, and the first GDP reading for the first quarter came in at 0.6% – the same as the fourth quarter. This was about what was expected but many had been braced for a negative, and thus recession-indicating, result, so this appeared to be good news. The Dow spent the bulk of the morning hovering around 12,950, which was up 120 on the day.
A deathly hush then descended at 2.15pm and heartbeats began to race. A 25 point cut! Woohoo! While this was exactly what the market was expecting, there was lingering doubt of perhaps a more significant cut, indicating things had not improved as much since March as hoped.
The Dow shot up to 13,000 – a significant level just because of all the zeros. The S&P 500 shot up to over 1400 – ditto. This was the break-out the market was looking for. The US dollar rallied once more. Gold fell hard to below US$865/oz. Oil dropped over US$2.00. The long stock/short commodity play built up in recent weeks was paying off. But then…
But then traders took some time to read this (my emphasis):
“Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.
“Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.
“The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.”
Wall Street had been looking for a commitment from the Fed that 25 points was the last of it. They wanted some definitive indication that monetary policy would now remain on hold, which would indicate (a) financial markets have indeed stabilised or improved, (b) inflation would now be the Fed’s main concern and (c) the US dollar would not be allowed to tank further.
It’s not what they got. But then, they didn’t get much the other way either.
In the first paragraph, the Fed acknowledges that the US economy is weak. Okay, we all know that. But it also suggests that financial markets “remain under considerable stress”. If you took that paragraph alone, you’d say the Fed is not done cutting yet.
The second paragraph addresses inflation. The Fed suggests core inflation readings have improved. So what Ben? The important part is that “energy and commodity prices have increased”. That’s what we want you to fix. But then the Fed says it “expects inflation to moderate in coming quarters”, which tends to indicate that the Fed is not concerned enough that specific monetary policy action is needed at this point to fight inflation. The Fed will “continue to monitor inflation”. This paragraph could be interpreted as “we could still cut again if we have to because we’re not that concerned about inflation rising”. Or it could be, “we’ve got our eye on inflation so we won’t be doing anything until we get a better picture” – ie, “on hold”.
The third paragraph is the most powerful one for the “on hold” argument, as the Fed notes the “substantial easing” to date which “should help to promote moderate growth”. In other words, “we’ve probably done enough now”. But the Fed says it will continue to “monitor economic and financial developments and will act as needed”, which has been a stock phrase for the last few months. By keeping this phrase running, the Fed is still suggesting that it depends on the data as to what we do or don’t do next.
As important as what reappeared in the rhetoric is what was removed. For the first time in many months the Fed statement did not include the words “risks remain to the downside”.
So – is the Fed “on hold”? About the best interpretation one can make from this (probably deliberately) ambiguous and vague statement is that the Fed is on hold until it isn’t. Once again, it’s wait and see. But the Fed will still “act as needed” on the data flow. Maybe the acknowledgement of the “deepening” housing contraction in paragraph one is the best clue. Is the Fed definitely on hold? No.
It took about 15 minutes for Wall Street to digest this statement and make its call. It was a disappointment. The Dow turned around and quickly gave back 190 points to close at 12,820 – down 11 points on the day or 0.1%. The broad market S&P spun harder, falling from the intraday high of 1404 to close at 1385 – down 0.4%. The Nasdaq faired worse, and closed down 0.6%.
The US dollar fell, the euro rallying back about half a cent to US$1.5627. A 25 point rate cut will normally cause the dollar to fall anyway, but this was what the market anticipated. It was the lack of conviction on inflation from the Fed that sparked weakness in the dollar – weakness which may now set in for longer once more. The Aussie shot up a cent to US$0.9436.
Gold spun on its heels and turned a fall of over US$6.00 into a rally of US$6.30 to US$877.90/oz. Oil also spun and turned a loss of over US$2.00 into a loss of US94c to US$114.69/bbl. That oil didn’t move back into the green was representative of the US weekly inventory numbers, which for the second week running showed a higher than expected increase.
Base metals in London did not make any moves of note for the simple reason London closes just before the Fed does its stuff. New York markets also close early to coincide with the end of London late trade. Thus we have only small and mixed adjustments, pending tomorrow’s session. However, as base metals have been in two minds for the best part of the month it’s unlikely this Fed statement is going to tip the balance one way or another. Positive if anything.
The SPI Overnight closed down 9 points.
Now what?
