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The Fed Cuts One

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      06-25-2003           High     Low     Volume   Adv/Dcl
DJIA     9011.53 - 98.32  9161.74  9000.68 1.74 bln 1538/1332
NASDAQ   1602.66 -  2.95  1629.97  1600.28 1.53 bln 1653/1423
S&P 100   491.60 -  4.89   500.76   491.40   Totals 3191/2755
S&P 500   975.32 -  8.13   991.64   974.86 
W5000    9333.19 - 54.80  9468.13  9328.46
RUS 2000  443.21 +  2.32   446.36   440.89 
DJ TRANS 2356.13 - 32.98  2393.62  2352.87   
VIX        23.19 +  0.43    23.97    22.73   
VXN        31.95 -  0.48    32.98    31.34 
52wk Highs  158
52wk Lows    21
PUT/CALL   0.78

The Fed Cuts One
By Jonathan Levinson
Click here to email Jonathan

The Federal Reserve surprised no one but the treasury market today, announcing a 25 basis point rate cut and maintaining its easing bias. The biggest reaction was in the treasury market, which saw yields spike following the announcement.

Daily Chart of the INDU

Today's selloff brought the indices to trendline support and confirmed the oscillator sell signals. If the trendline fails, there's an excellent chance that we've seen the top of the rally. Last week's gravestone doji would fit well with that scenario.

Daily Chart of the COMPX

The Mortgage Bankers Association (MBA)announced this morning that seasonally-adjusted demand for mortgage refinancings, the MBA refinancing index, fell 10.5 percent to 8,204.6 in the week ended June 20. Demand for loans with which to buy homes, the Purchase index, dropped 1.9 percent to 411.2. The MBA's market index, an overall measure of mortgage activity, fell 8.7 percent to 1,554.5. The average contract interest rate for a 30-year fixed rate mortgage rose to 5.10 percent from the previous record low of 4.99 percent during the previous week, causing refinancing activity to drop to 75.8 percent of total applications from 77.3 percent the previous week.

The Commerce Department said that U.S. durable goods orders fell 0.3 percent in May, the second decline in a row. The industrial sector saw weaker demand in May, led by a 13.8 percent drop in orders for defense capital goods. Core non-defense, non-aircraft capital goods orders fell 0.5 percent. Expectations had been for a 1 percent gain after durable orders fell a revised 2.4 percent in April. Unfilled orders fell 0.1 percent.

No doubt fueled by the record low interest rates being widely reported everywhere over the past month, the Commerce Department announced that annualized sales of new dwellings rose to a record 1.16 million units in May. The 12.5 percent increase was the largest in one month since September 1993. Expectations were for 1.03 million units. The number broke the previous record of 1.057 million set in September 2002. April's level was left nearly unchanged at 1.03 million units.

The Fed Funds rate was brought to a level not seen since 1958 by today's quarter-point cut. In other words, money is as cheap as its been in 45 years. While my data doesn't go back that far, here's a view of the money supply, and what's been the result of the Fed's rate cuts since it began 13 cuts ago:

MZM chart

I've been harping on the dubious effectiveness of these cuts, other than to create jobs in China (see last week's discussion of the current account deficit), a mortgage bubble, and, arguably, a stock and treasury market bubble. The money injected by the Fed has not, unfortunately, found its way to the one sector that could spark a real recovery:

Chart of Commercial and Industrial Loans (St-Louis Fed)

The above chart is confirmed by the persistent unemployment we've been following. We await the initial claims data to be released tomorrow, but in my opinion, a drop in unemployment will be the true recovery, the one that we can trust. So far, it has yet to appear.

In other news, the Energy Department reported a 4.1 million- barrel drop in U.S. crude oil inventories for the week ended June 20. The move surprised analysts once again, this time expecting a rise. It would appear that the job of analysts covering this sector is to be surprised, which they have done with remarkable consistency for the past two months. Total inventories are 284.2 million barrels, or 11.5 percent below this week's level one year ago. Gasoline inventories were lower by 900,000 barrels at 208.2 million barrels during the week ended June 20. Distillate supplies were unchanged at 109.4 million barrels. Crude oil futures closed just below $30 per barrel.

The Federal Energy Regulatory Commission announced its ruling barring Enron from selling electricity and gas in the United States. "This is the first time the commission has imposed the so-called 'death penalty'," said FERC Chairman Pat Wood. "By revoking the company's authority to sell electricity at market- based rates, we send a clear signal that the markets must work in interest of consumers and the public interest."

In the ongoing saga of FRE's accounting woes, the company today made public details of its restatement of financial results. FRE expects the cumulative effect of the required changes to increase its retained earnings as of Dec. 31 by $1.5 billion to $4.5 billion. The company expects to report a material increase in the fair value of shareholders' equity for year-end 2002 from 2001. The company attributed the increase in its retained earnings to "gains on certain derivatives and mortgage securities that will be marked to fair value during periods in which interest rates were declining." FRE warned that the accounting policy changes being implemented "will cause greater volatility in Freddie Mac's financial statements for prior periods," and it believes there will also be "significant volatility" in results for future periods. No kidding. Many observers have complained of the absence of transparency in accounting for derivatives positions, and the difficulty in accounting for over-the-counter, illiquid instruments. This is one of the "new" factors in our markets, and the volatility and enormous leverage of such positions presents new risks for investors to attempt to evaluate.

GS reported earnings of $695 million for its fiscal Q2, up from $563 million in the prior Q2. Earnings per diluted share were up $1.36, up from $1.06 and beating expectations of $1.19. Revenue, net of interest expense, rose 3 percent to $3.99 billion. The company also announced an increase in its dividend to 25 cents. Tomorrow, 50 million shares come out of lockup, which should pressure the stock downward against today's good news.

For tomorrow, we have a full slate of economic data due before 
the bell:

              Report                     Briefing  Market   Prior
                                         Expects   Expects
Jun 26 8:30 AM Chain Deflator-Final Q1 -   2.5%    2.5%     2.5%
Jun 26 8:30 AM GDP-Final Q1 -              1.9%    1.9%     1.9%
Jun 26 8:30 AM Initial Claims 06/21 -      425K    415K     421K
Jun 26 10:00 AM Help-Wanted Index May -      36      36       35
Jun 26 2:00 PM FOMC Minutes 

For tomorrow, the outlook is decidedly bearish but for the trendline support yet to be tested. I believe it will ultimately fail, but the possibility of an intervening bounce cannot be ignored. Tomorrow's opening data is "market moving", and the tone will likely be set before the bell.


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