Markets Listen for Cooing of Dovish Fed

Federal Reserve Board Of Governors Open Meeting
Andrew Harrer/Bloomberg via Getty ImagesFederal Reserve Chairman Ben Bernanke
By Patti Domm

Markets are primed for a dovish statement from the Federal Reserve on Wednesday that should keep a lift in stocks.

The Dow and S&P 500 rallied to record highs Tuesday, as traders bet on an uneventful outcome when the Fed ends its two-day meeting Wednesday afternoon.

"They put the possibility of a surprise tapering at zero," said Art Cashin, director of floor operations at UBS. He said there was some short-covering as traders assumed the Fed would not announce any reduction in its $85 billion monthly bond-buying program.

The Fed issues its statement at 2 p.m. Eastern time, and there is no press briefing with Chairman Ben Bernanke this month. Fed watchers do say the Fed could tweak its view on the economy, to show the uncertainty that has resulted after the government shutdown.

Traders also will be more focused than usual on the 8:15 a.m. ADP private sector employment report, expected to show 150,000 private sector jobs were added in October, slightly weaker than the 166,000 added in September. The government's monthly employment report usually follows ADP within two days, but because of the government shutdown, the October jobs report will be delayed until Nov. 8.

"The perception of the accuracy of ADP has increased, so I think the market might be paying more attention to it," said Ian Lyngen, senior Treasury strategist at CRT Capital. "It's the most comprehensive early glimpse we have of employment in October. Any caveat about the impact of the government shutdown will be of note."

Employment is a key metric for the Fed, and the September jobs report was disappointing when it was released after a several week delay. Only 148,000 nonfarm jobs were created in September, and economists expect the government's October report to be weak due to the 16-day government shut down.

The Fed surprised markets after its September meeting, when it announced no change in its bond purchases, so every new employment report is important. %VIRTUAL-article-sponsoredlinks%The Fed instead cited financial conditions and concerns about fiscal headwinds as reasons not to cut back.

Knapp said historically the market has corrected when the Fed pulls back from easing, with an average 8 percent decline. "We basically pushed that correction into next year," he said.

The CNBC Fed Survey this week found that Wall Street now expects the Fed to maintain its current level of purchases of Treasury and mortgage securities until April.

"They're on hold until they can get a cleaner read from the data that's not distorted by government shutdown and they reassess where the economy stands," Lyngen said. "There is tail risk that the Fed does something more hawkish that the market is not prepared for. I would ascribe a very small probability but that's the one thing that could shock the market."

The Dow (^DJI) on Tuesday soared 111 points to 15,680, besting its Sept. 18 closing high and catching up with other indexes that had already set new highs. The S&P 500 (^GPSC) was up 9 at 1,771, and the Nasdaq (^IXIC) rose 12 to 3,952.

"We have this favorable set up where public and monetary policy are both generally improving. I think the economic outlook is generally improving as well," Knapp said.

He also said the market is now in a seasonally positive time. "There were only four fourth quarters since 1990 when the returns were negative," he said. The last time the market registered a loss in a fourth quarter was when the recession was in full swing in 2008.

"I don't see much to stop it now," Knapp said. He said he expects the upcoming budget negotiations in Washington to be less contentious and he does not expect the Fed to announce that it will taper its bond buying until March.

Jack Ablin, CIO of BMO Private Bank, said Fed officials may say something more hawkish to keep the markets thinking about tapering, even if they don't do it yet.

"My guess is they're going to take a more hawkish tone. I think they're going to have to get the idea of tapering in the future back in the system. I don't think they do it. I just think they have to talk about it again," he said.

But that should not stop stocks from moving higher. The S&P 500 "is about 10 percentage points above the 200-day moving average. This is a very good story. The most likely scenario is the market tends to gain 10 to 15 percent in the subsequent 12 months," said Ablin.

The Fed likes the animal spirits it is creating, he said. "What they want to do is have their monetary policy stimulate activity but they don't want to create a bubble in the meantime," he said.

Besides ADP, the delayed consumer price index for September is released at 8:30 a.m. There is oil and gasoline inventory data at 10:30 a.m.

There is also a big batch of companies reporting earnings. Before the bell, General Motors (GM), Chrysler, Comcast (CMCSA, CMCSK), Sanofi (SAN), Honda (HMC), Corning (GLW) and Booz Allen Hamilton (BAH) are among companies that will report.

Facebook (FB), Kraft Foods (KRFT), Allstate (ALL), MetLife (MET), Boston Beer (SAM) and Weight Watchers International (WTW) report after the close. Visa (V) also reports in the afternoon, with its first earnings release as a Dow component.

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Markets Listen for Cooing of Dovish Fed


So you're seeing a lot of strength in housing, and it's coming from almost every place geographically ... So that's sort of the big winner. Auto and that whole complex is a big winner. They're doing over 15 million cars this year, up from 8.5 at the bottom. And then you have the energy complex, which is really, really a revolution. This is hard to underestimate the impact of energy and all the natural gas that's being produced and all the subsidiary types of things that come from that activity. And if you add on top of that, technology which is still a very big pocket of strength and quite robust in the United States, you've got some really good stuff happening.

On the other hand we do have the U.S. government at work, trying to decrease growth as rapidly as they can. And so they've, unfortunately, had some success in that area, and that leaves us somewhere in the 2%-plus area.

We think that the next big risk in the industry is rising interest rates. And so we're very focused on what happens when interest rates return to a more historically normal level.

On the positive side, economic fundamentals in the United States continue to improve. The main impediment to growth appears to be the speed and nature of the withdrawal of fiscal stimulus. Debate has actually now opened up on how and when to withdraw some of the monetary expansion. All of this is very good news.

At the same time, the rest of the world looks no stronger. Europe is mired in a recession, Asian growth seems more modest and Japanese attempts to restimulate their economy through monetary stimulation have set off further downward pressure on interest rates and currency values.

The overriding driver of recovery in the housing market remains the underproduction of both single and multifamily product throughout the economic downturn and up to and including this year. Over the past 5 years of housing production, we've built an average of under 700,000 single and multifamily homes total per year, with an average obsolescence rate of approximately 300,000 per year. This compares to a need for new dwelling units per year of between 1.2 million and 1.5 million.

This year, a significantly stronger year of building activity, we will produce approximately 950,000 single and multifamily dwellings, and again, will underserve the country's needs. We have more than absorbed the overbuilding of the early to mid-2000s, and have been underproducing for a protracted period of time. This shortfall will have to be made up, and the builders of both multi and single-family products have been pushing to increase production.


I think when you look at some of the economic indicators, housing starts are up, prices are up on housing. I think housing is a really important measure for us because we have a lot of jobs around that. A lot of contracting roofers, et cetera, around that. All of that is positive. And so we're feeling like we're coming off the end of the year with some momentum, and that will certainly help us.

I think there's reason to be very optimistic when you consider that demographic tailwind that will continue over the next 5 to 10 years, certainly. And then when you think about just the economy itself and you look at the strength of the balance sheets of consumers and corporations, the amount of liquidity out there, combined with the depth of the housing correction, I think there's a good argument we made that the housing cycle we're in right now will be strongest of the last 3 that we've seen.


Although we have seen recent improvements in the U.S. economy, growth is relatively light and confidence remains fragile. In addition, while the market generally feels better about the tail risk in Europe, the economy is challenged.

Given the continued uncertainty in the market, we are not managing the firm with the hope that the macro backdrop will improve. We are focused on managing through a continued difficult operating environment.

We continue to be very concerned about the prospects for the financial markets and the economies of North America and Western Europe, accentuated by potential weakness in China. There continues to be a big disconnect between the financial markets and the underlying economic fundamentals.
Markets are firming. If the economy continues to expand like it is, I think you'll see the banks loosen up. And if sort of rates go up a little bit but underwriting loosens up a bit, I think you'll see similar demand, if not more. That's why we're not troubled by a little uptick in interest rates right now.

The situation in Europe is not even slightly better. It's probably slightly worse. Even if we do not have a Greece event, if you will, the environment is moving from an economic standpoint to recession. And so the mood with our clients over there is still to be thoughtful and to be very mindful about the way they invest. And when clients are thoughtful and mindful, they tend to wait a little bit more and to think further on when and how much they're going to invest. 



"I think the whole thing about the 2% extra payroll tax wasn't helpful. Don't forget, in America, the average household makes $50,000. 2% is $1,000 a year. I mean, after tax, that's a hurt in their pocketbook. Gas prices have been going up. I -- and you've seen the retailer results, the Walmarts, Kmarts, Targets, Costcos of the world had, had results less than they expected, not very good. So it's weak. I don't think it's -- I'm not ready to declare it's a permanent decline or a second dip on the recession there, but it's a little nervous as far as what's going on up there."



We're really proud now that the [government budget] deficit could only be $600 billion in the year, and while that's encouraging, it doesn't do anything to fix the long-term problem, and the long-term problem is entitlements. If you take a look at the Medicare and Medicaid in particular and some on Social Security that while debt as a percent of GDP is we'll say around 75% today and under the new estimate grows to 83% by the end of the decade ... You take those same numbers, go up to the next decade and it goes to 135% debt as a percentage of GDP largely driven by the baby boomer generation retiring which no politician, Republican or Democrat, really wants to talk about. They're more than willing to say we got to reform entitlements but as soon as you say well, like what, that's when they all start to back off because they don't want to anger the voters.

I think there's a lot of concern about central banks not just in the U.S., China elsewhere, and maybe they stretched themselves out, and they played this maybe game, you want to call it for quite a while and maybe they are getting a brick wall, and the days of easy and free money may be coming to an end or at least maybe tapering off. But it probably wouldn't be good [for the global economy in the short-term], maybe good for long-term because then it would be more based upon fundamentals rather than speed injections.

Photo: Park Electrochemical

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