Wednesday, December 16, 2009

Early Rally Battered by Fed Rate Decision

Although there was no change in federal funds rates when the FOMC announced their decision at 2:15 pm on Wednesday, there was enough of an indication from the central bank committee that other aspects of their recent easy money policy were coming to an end. The statement which accompanied the "no change" decision was sprinkled with enough mention of the end of certain Fed programs and strengthening economic conditions to scare off year-end investors as the trading session ground to a close.

Even their opening sentence, "Information received since the Federal Open Market Committee met in November suggests that economic activity has continued to pick up and that the deterioration in the labor market is abating, " was more bullish than previous announcements, a sign that the Fed would probably change the key wording: "exceptionally low levels of the federal funds rate for an extended period" within the next two meetings and that rate increases would be forthcoming by Summer of 2010.

The trick for traders is in the timing of their trades and the key at this particular time is to get out ahead of any Fed rate increase, because that event will almost certainly result in halting stocks' heady advance. As it is, the great rises in stocks has recently abated to a large degree, as trading since the last Fed meeting has been mostly sideways to slightly higher. Locking in gains or selling losers for the year would seem to be imminent following one of the last great market-moving events of the year.

With strong mention concerning the ending of certain liquidity programs, the Fed's last paragraph really set the tone for this meeting and what would occur in terms of policy in the first months of 2010.
In light of ongoing improvements in the functioning of financial markets, the Committee and the Board of Governors anticipate that most of the Federal Reserve’s special liquidity facilities will expire on February 1, 2010, consistent with the Federal Reserve’s announcement of June 25, 2009. These facilities include the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility. The Federal Reserve will also be working with its central bank counterparties to close its temporary liquidity swap arrangements by February 1. The Federal Reserve expects that amounts provided under the Term Auction Facility will continue to be scaled back in early 2010. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30, 2010, for loans backed by new-issue commercial mortgage-backed securities and March 31, 2010, for loans backed by all other types of collateral. The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.

With all of these programs coming to an end, the Fed obviously sees the US economy as essentially healed and will begin to focus more on reining in liquidity and keeping inflation under control. Most astute economy watchers believe that the Fed will begin to raise rates during the second quarter of 2010, if not sooner, and will increase them 25 to 50 basis points at a crack until the end of the year. By this time next year, the federal funds rate should be approaching 2% with 2 1/4% at the high end. That should certainly be accommodative enough to keep stocks from keeling over and low enough to not hamper economic growth.

As the market wound down, traders took the Fed's message to heart, trimming some of the day's earlier gains and actually sending the Dow to its second straight negative close. Other indices managed to hold onto marginal gains. The broader market, as measured by the NYSE composite, outperformed all other indices handily.

Dow 10,441.12, -10.88 (0.10%)
Nasdaq 2,206.91, +5.86 (0.27%)
S&P 500 1,109.18, +1.25 (0.11%)
NYSE Composite 7,180.76, +39.32 (0.55%)


Simple indicators were out of line with the modest headline numbers, most likely due to speculation on less-followed stocks as options expiration neared (Friday). As a matter of fact, much of the movement in stocks the past two days was more than likely unduly influenced by options, as Friday is a quadruple witching day. Advancing issues finished well ahead of decliners, 4089-2429. New highs outpaced new lows, 538-83. Volume was better than normal, another factor of options expiration at the end of the week.

NYSE Volume 5,370,022,500
Nasdaq Volume 2,037,267,500


Commodities responded to a weaker dollar prior to the Fed announcement, though the buck strengthened after the decision. Oil rose $1.97, to $72.66, though much of that gain was attributed to government figures showing a decline in inventory of 3.9 million barrels. Gold gained $13.00, to $1,136.00; silver was higher by 24 cents, to $17.70.

Other economic news included November CPI data which showed consumer prices increasing at a rate of 0.4%, in line with expectations. Housing starts and building permits were also up.

Looking ahead to Thursday, initial unemployment claims are expected to continue to moderate down to 450,000, though that number would, in normal times, be a cause for panic, considering it is the height of the retail season and jobs should be plentiful. Such a number indicates that the economy is not as yet fully healed, with jobs creation remaining extremely weak. Uncertainty of government measures, notably the health care debate and consideration of higher taxes, plus the overhang on business from last year's near financial meltdown, are contributing to slack demand for labor.

That should ease by Spring and Summer of 2010, but for now, the numbers are still quite discouraging, especially for those seeking employment.

Fed Chairman Ben Bernanke was named Time magazine's Person of the Year, which was probably more of a planned coincidence than happenstance. Bernanke is scheduled to be re-appointed for another term by the Senate tomorrow. Speaker of the House Nancy Pelosi was runner-up for the honor, which says plenty about the rigor of the selection committee.

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