Market Commentary

Was the FOMC statement virtually as expected?
December 17, 2009

Was the FOMC statement virtually as expected?  The assessment of economic activity was upgraded and the abatement in the deterioration in the labor market duly noted.  The improvement in housing was specifically highlighted. Household spending is now improving “moderately” as opposed to “just expanding.”  Financial market conditions are now believed to have become supportive to economic growth.

But despite the upgrade the FOMC still expects economic activity to “remain weak for a time”, inflation “subdued,” capacity utilization “at a low rate” thus permitting the fed funds rate to remain “exceptionally low for an extended period.”

In my view the language is incrementally less dovish but does not suggest a change in monetary policy is imminent.  Both equities and treasuries viewed the statement as a non event as evidenced as both closed virtually unchanged.

All are pondering when the inevitable change in monetary policy will occur.  All know the Central Bank waited 12 and 20 months, respectively, after unemployment peaked in the last two recessions before altering monetary policy.

What are the odds a change in monetary policy will occur in January or March?  As widely noted the unemployment rate fell in November to 10.0% from 10.2% with a good possibility the headline rate could fall again in December.  The critical holiday shopping season is over. Bernanke would be reconfirmed as Fed Chairman by that time. 

In my view one of the greatest potential threats of 2010 will be the “un anchoring of inflationary expectations” if the Federal Reserve does not move decisively in ending its “quantitative easing program.”

I think equities could be in a period of rough sledding in the early part of 2010.  Why?  Profit margins and productivity is huge, the result of firing 5.4 million people about 8-10 months as companies panicked from October-July to ensure survivability, the most basic instinct.  If corporations are forced to add workers because of economic activity, margins and productivity suffers.

Secondly, interest rates are the largest component of most valuation formulas.  Higher interest rates suggest that companies will need higher earnings to support valuation.  If profits decline because of additional workers, so will prices.

However I also believe this decline will be short lived as such activity will convince all the recovery is indeed sustainable.

At risk of pushing my editorial privilege I do believe Washington will replace the credit crisis as the major potential event risk.  I think companies could delay expansion plans until the outcome of the Administration in known. 

What will happen today?  The Index of Leading Economic Indicators, the Philadelphia Fed and weekly Initial Jobless claims are all released.

Last night the foreign markets were down.   London was down 0.80%, Paris down 0.50%  and Frankfurt down 0.55%.  Japan was down 0.13% and Hang Sang down 1.22%.

The Dow should open nominally lower.   Citicorp raised the most amount of monies ever in an equity offering--$20.5 billion--albeit the price was disappointing.   However I think it is amazing that Citicorp was able to raise this much money especially given the almost universal consensus view eight months ago that the capital markets would be closed to these banks for many years.  The 10-year is up 16/32 to yield 3.54%.