Zombie Economy Overshadows Fed Meeting

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APFederal Reserve Chairman Ben Bernanke

By Patti Domm

GDP data Wednesday is expected to show a slow-moving, zombie-like economy, as the Fed meets for a second day.

Many economists expect second quarter growth to be paltry, less than one percent, and some think that data could help shape the Fed's thinking if it's even weaker than expected. The first quarter grew at a 1.8 percent rate.

The Fed meanwhile, isn't expected to say much new when its meeting ends. The 2 p.m. Eastern time statement isn't seen altering what Fed Chairman Ben Bernanke has already said about the Fed's plans to taper bond purchases before the end of the year. But it may adjust its comments to reflect a temporary slowing of the economy. The Fed, and many economists, expect a stronger growth rate in the second half of the year.

"[Wednesday] is an action-packed today. It's one of those weird ones where it's so action-packed, what if it is a dud?" said George Goncalves, Treasury strategist at Nomura Americas. "We have all these high expectations -- GDP, revisions to GDP, ADP, the Treasury going to announce at 8:30 their intentions for borrowing. We have the Fed later on."

It is also the end of the month, and that could make markets more volatile as traders square positions. For July, the S&P 500 is up five percent, bringing its year to date gain to 18.2 percent, The Dow was up four percent in July so far. Markets Tuesday were in a wait-and-see mode ahead of the Fed's announcement Wednesday. The Dow Jones industrial average (^DJI) edged 1 point lower to 15,520 and the S&P 500 (^GSPC) rose less than a point to 1,685.

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The 10-year Treasury note was at 2.61 percent Wednesday. Traders are watching that yield level, as a move higher could take the market to a potential nervous zone for stocks.

"We've had a little bit of a backup in yields. [Month end] could amplify whatever's happening toward the end of the day," Goncalves said.

"I think GDP will be constructive. I think it's still coming in on the weak side. The Fed will react to it by not being too hawkish. Then we're going to quickly turn our attention to [nonfarm payrolls] on Friday," he said. The Fed has said it would base its tapering decisions on economic data , and it is particularly focused on employment so some traders expect to get more new information from the jobs data than the Fed statement.

The 8:30 a.m. Eastern time GDP release is also be important because the government will release revisions in the data going back to 1929. It last issued massive revisions in 2009. "It's clear the level of GDP is going to be higher by a substantial amount, maybe 3 percent," said Goldman Sachs Chief U.S. Economist Jan Hatzius.

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The revisions are expected to boost the level of GDP but not necessarily change the growth rate of GDP in recent years. "We're at 0.6 percent," for the second quarter, Hatzius said.

The revisions will include a new method to count research and development spending as a form of investment spending. Spending by entertainment and media companies on movies and certain other entertainment will now be considered investing in intellectual property. The revisions also include additional source data and recalculate seasonal adjustments.

JP Morgan (JPM) Chief U.S. Economist Michael Feroli said expects the Fed to be vague about the timing of its plans to taper back the $85 billion in monthly bond purchases. He expects the Fed to begin to move in September and start by cutting purchases by $20 billion a month in mortgage securities and Treasurys.

"To the extent we're right, that it is going to come in a very soft Q2 number, the Fed's known for a while. Even when Bernanke went before Congress and testified. He knew the Q2 print would be very bad and he didn't do anything to soften expectations for tapering later this year," said Feroli. J.P. Morgan expects second quarter growth of a half percent, but Feroli sees a pickup in the second half other year to 2.5 percent.

Feroli said the Fed could give a nod to the softer data. "I think they'll be able to ascribe some of it to transitory factors such as fiscal drag," he said.

There is some expectation the revised GDP data could help explain why GDP has been lagging other data for the last couple of quarters, especially the employment data. Other releases Wednesday include ADP's private sector payroll data at 8:15 a.m., and that number is expected to be around 183,000, down from 189,000 last time. That number is seen as a sort of precursor to Friday's July jobs report, expected to show 184,000 payrolls. The Treasury is also expected to announce the auction sizes for its next fiscal quarter at 8:30 a.m.

There is some talk the Fed may change its target of 6.5 percent unemployment for an area to begin to move short term rates, down to six percent. However, some economists think the Fed will wait for a later meeting to make any adjustments. Unemployment, at 7.6 percent last month, is expected to fall to 7.5 percent in July.

"Our view is it's steady as she goes for a lot of things. Now is not the time for the Fed to be doing anything, but just clarifying stuff," Goncalves said. "If ADP is bad, and it's followed by weak GDP, they could sound very dovish for sure." He and others say the Fed could choose to taper back a smaller amount in September if the data doesn't pick up.

There is also a blast of early earnings news, including reports from Comcast (CMCSA, CMCSK), CBS (CBS), MasterCard (MA) and Burger King Worldwide (BKW).

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