Worries over how the Fed may change their statement on Wednesday kept traders on the sidelines and the markets in limbo.

Market Stats Table

While traders wait patiently for Wednesday's FOMC announcement on rates there were plenty of economic reports to watch. The existing home sales for May came in weaker than expected at 4.77 million annualized units. Analysts were hoping for a rise to 4.80 million compared to the 4.68 million in the April report. The 4.77 million units was the highest sales rate since Oct-08. Months of supply fell to 9.6 from 10.1 in April. The 12-month average of months of supply on the market is 10.2 months so conditions are improving. The 12-month rate of sales chart below appears mildly bullish if that is all the data you saw. When viewed in the larger time frame of the last decade the slight uptick over the last couple months is nearly lost in the bigger picture.

12-Month Existing Home Sales

10-Year Existing Home Sales

The other housing report out today was the FHFA purchase-only house price index, which declined a meager -0.1% in April. Over the last 12 months the index declined -6.8%. However there are signs of improvement. The mountain division actually rose +1.3% and the New England division rose +0.9% and west central rose +0.6%. The west south central division fell -0.7% for the biggest decline but that division is only down -1.3% over the last 12 months. As in every housing index the FHFA index is also showing an overall improvement.

FHFA Home Price Index

Meanwhile fewer people can afford to buy a house because job losses are still increasing. The U.S. Mass Layoff report for May showed that layoff events involving more than 50 workers increased to 2,933 in May from 2,712 in April. The number of workers losing their jobs rose to 312,880 in May from 271,226 in April. This is a new record high for mass layoffs and shows continued weakness in the job market. Analysts claim that budget shortfalls in state and local governments will accelerate the number of layoffs this summer and fall. States are finding budgets impossible to balance and large numbers of layoffs will result.

Most states are not as bad as California but they are still hurting. The news in Colorado yesterday was a move by the governor to cut services immediately to head off a $250 million budget shortfall expected this year. Relative to California's massive deficit of billions our $250M is pocket change but it still means thousands of state employees will lose their jobs. This is a problem that every state is facing and will help push unemployment over 10% by years end.

Mass Layoff Chart

The last report for the day was the Richmond Fed Manufacturing Survey. The headline number rose to +6 from +4 and the second consecutive positive month after falling as far as -55 back in December. The internals continued to improve with new orders up to 16 from 9 and order backlogs rising from -3 to +8. Holding the index back slightly was a drop in the six-month outlook falling from 28 to 23 and shipments falling from 9 to 2. This rebound is probably just an equalization of pressures and is far from a resounding recovery.

Richmond Fed Survey

Economics for tomorrow include Mortgage Applications, Durable Goods, New Home Sales and Oil Inventories. However the biggest problem for Wednesday is the FOMC announcement. This is going to be a critical meeting and a critical point in the Fed's management of the financial crisis.

The Fed is expected to say they are seeing some green shoots but the recession is ongoing. How they paint the word picture of the continuing recession is going to be key. The Securities Industry and Financial Markets Association (SIFMA) issued a report today saying the real GDP would rise by +0.8% in Q3 and +1.9% in Q4 but the full year GDP would contract at -2.7%. The current recession was expected to be the longest since the great depression. Growth for all of 2010 was only seen as 2.1%.

The Fed is probably seeing the same numbers and they have to decide if the problems are still bad enough to keep the rate outlook stable. There is only a 47% chance of a rate hike at this meeting according to the Fed Funds Futures but nobody actually expects a hike at this meeting.

What they expect the Fed to do is tighten their bias statement to allow them to start the rate hike cycle at some point in the future. However, SIFMA said their members do not expect a rate hike until late in 2010 because of lingering recession issues like unemployment. SIFMA says inflation is nonexistent because of excess capacity and there is no reason to kill any green shoots with rate hike fear.

With the unemployment rate at the highest level since 1983 there is no chance for inflation and a stronger statement by the Fed will only push more employers to hold off on hiring until they are sure the economy is on a recovery path. SIFMA actually saw inflation slowing from 1.6% in 2009 to only 1.2% in 2010.

The key sentence in Wednesday's announcement will reference the "extended period" for rates remaining low. If the Fed leaves that sentence intact then the markets should recover. If the Fed removes that phrase the markets could flounder depending on what additional language they add. I seriously doubt the Fed will do anything to push rates higher. They have already committed to buy $1.45 trillion in mortgage related debt by year-end and $300 billion in longer-term treasuries by mid September. Why would they want to push rates higher before nearly $2 trillion in purchases? Paul McCauley at Pimco said the Fed should take a dramatic step and actually add to the statement that inflation is not going to be a problem and could actually be too low and then confirm again that they are going to leave rates low. By adding confirmation to the statement it would keep speculation low for future meetings. The announcement is at 2:15 ET.

The government auction for $40 billion in two-year notes went off with a bang today with a bid to cover of 3.19 to 1. This was the highest bid to cover rate in several years and over 70% of bidders were foreign buyers and institutions. The final yield was 1.15% and the highest since the fall of 2007. Despite the high yield this was the best of all possible outcomes to have three times more bids than the dollars offered. However, the twos are the easiest to sell. There will be $37 billion in five-year notes and $27 billion in seven-year notes later this week.

An auction for five-year notes was a problem with low bids and high yields last month. The Treasury has to auction $3.25 trillion in notes before their fiscal year end on Sept 30th and eventually we may run out of bidders. This is especially true on the longer-term notes because the foreign bidders are doubtful the U.S. will pull out of the financial crisis in the near future. That $3.25 trillion for 2009 compares to "only" $800 billion the Treasury sold in 2008.

The dollar is not showing the same strength as treasuries. The dollar fell hard on Tuesday to a new 8-day low. The falling dollar helped commodities but does not help stocks. The strength of the dollar is directly related to the implied strength of the US economy.

Dollar Chart

A gray industry is seeing green shoots. U.S. Steel (Nyse:X) said it was considering a restart of at least one blast furnace in the U.S. due to a recent uptick in orders. The ArcelorMittal CEO said they were seeing modestly improving demand and recovering investor confidence. "Chinese steel demand is now forecast to show growth this year compared to a previously expected decline" according to the CEO. The US Steel CEO said the capital markets seem to believe the worst is behind us and that leads to future investments. However, the ArcelorMittal CEO said he did not expect strong demand to return until 2011.

The green shoots in the steel sector have not spread to the airline sector. The Air Transport Association (ATA) said today that passenger revenue fell -26% in May compared to May 2008. The number of passengers fell -9.5% while the cost per mile to fly fell -17.6%. Cargo traffic fell -22% for the ninth consecutive month of declines. Don't worry about the airlines making a profit. Two airlines announced plans last week to charge for bathroom access. After charging for bags checked, preferred seating, blankets and pillows, food and drinks, headphones and videos I guess it was the logical choice to charge for bathroom breaks. Next they will charge us a fee to put a bag in the overhead bin. United said it would make $275 million in 2009 from the extra fees.

Boeing (Nyse:BA) took another hit today after they announced the fifth delay for the 787 Dreamliner. The first test flight was planned for next Wednesday and now it has been canceled. Boeing said some stress points had developed where the wings attach to the body and those problem areas would have to be repaired and strengthened before any flight could occur. The 787 is made almost entirely from carbon fiber composites instead of aluminum. The major components are made by other factories around the world and shipped to Boeing. In this case the wings are made by Mitsubishi in Japan and the side-of-body mounting structure by Fuji. Boeing said the new schedule for test flights and customer deliveries would not be announced for several weeks as Boeing decided how to fix the stress points. Boeing has sold 866 of these planes and they are already more than two years behind in deliveries. So far the buyers are sticking to their orders. If the first plane crashed in testing because the wings fell off I doubt those orders would be so large. Boeing was the major drag on the Dow with a -$3 loss on the news.

Boeing Chart

Three banks have quit making dividend payments on their TARP loans because they can no longer afford the payments. Pacific Capital Bancorp, Seacoast Banking and Midwest Banc Holdings have quit paying dividends on the $315.4 million they received under the TARP program. The Treasury said it respects the rights of the banks to withhold the dividend payments as a cash flow tool. Yes, but will they continue to respect them if they eventually fail? I wonder, if the FDIC closes a bank that took TARP loans do those loans go away? I doubt any takeover bank would want to assume the TARP debt. Apparently there are some other undisclosed banks also not making the payments so this is a sign that problems still exist in the banking community.

After the bell Oracle (Nasdaq:ORCL) reported earnings for last quarter that came in at the top end of estimates at 46-cents. The range given by Oracle was 42-46 cents and analysts were expecting 44-cents. Revenue of $6.9 billion was above analyst estimates of $6.47 billion. Gross margin climbed to 51% from 48.6%. Oracle rose slightly in after hours trading.

Ralph Acampora returned to CNBC today as a guest analyst and promptly said the Dow was going to return to 7500. Since he is now promoting his new book the "Fourth Mega Market Now Through 2011" it was surprising to hear him say he was rooting for the Dow to return to 7500. As a noted bull promoting a book about the current bull market Acampora said a retest of 7500 was necessary to free the market to rally into 2011. Oddly I don't disagree with him that a return to 7500 would produce a new support level that would allow those that missed it the first time to jump on the train. However, while that dip would provide a great entry point I would rather the market skip that investor stress test this time around.

The Dow closed today at just over 8300 and just over strong support at the 8200-8300 level. Monday's heavy sell off, on the announcement from the World Bank that the recession would be stronger and longer than previously expected, was not repeated. Trading was light and confined to a very narrow range. This is classic waiting on the Fed activity. The only question for traders is will the reaction to the announcement be a sell the news event or a rebound to erase the Monday loss?

Monday's drop produced a confirmation to the internals with the RSI and MACD clearly in sell mode but those have nothing to do with the Fed announcement. If trading were held in a news vacuum then putting your faith 100% in the indicators would be a valid strategy. However, the modern market is news driven more than anything else. The biggest news event for the month is the FOMC announcement at 2:15.

The Dow has fallen below its 30-day and 200-day averages but mostly due to the drop in Boeing, which has fallen -$10 in the last week. That equates to about 20% of the Dow points lost. With the close at 8316 the Dow has returned to a support level at 8300 that held for the entire month of May although there were several intraday dips to the low 8200s. If this 8200-8300 level breaks then Ralph may get his wish for a retest of 7500.

Dow Chart

The S&P-500 is holding above strong support at 880 but closed -4 points under the 200-day average at 899. The S&P has been stronger than the Dow but the relative support levels are the same. If the 880 level breaks it would suggest the rest of the summer could be ugly. The quarterly rebalance is now over so there is not a lot of outside influence pushing the S&P around. If summer is going to be a range bound event let's hope that range is 880-950.

S&P-500 Chart

The Nasdaq has been the leader but with Monday's -61 point drop that leadership is in jeopardy. Oracle reported good earnings after the bell today but the futures are negative at 7:PM ET. The Nasdaq is well above its strong support at 1650 and I sincerely hope we don't have to go there but anything is possible. The RSI penetrated support and appears headed lower but again, this is a news driven market. The Fed is in control of our destiny tomorrow.

Nasdaq Chart

With Boeing poisoning the Dow, the Wilshire 5000 remains the best indicator of true market strength. DWC 9000 is strong support and no single stock or group of stocks can push the Wilshire around. This is the market and as long as 9000 holds the rest of the indexes will eventually rebound. If this level breaks this could be an ugly summer.

Wilshire 5000 Chart

I don't need to repeat everything I mentioned above but it really is all about the Fed. Whatever they announce at 2:15 on Wednesday will send the market on a ride and nobody knows today in which direction. After Wednesday the volume will begin to decline again as traders close up shop for the July 4th holiday. There may still be some quarter end window dressing and still some Russell rebalance issues but volume should decline and trading slow to a crawl next week. If you are an adrenaline junky you probably already have positions on ahead of the Fed announcement. Personally I would look to buy any dip just in case a good statement triggers a sell the news event.

The video link below is a political cartoon. Don't click it if you don't like political humor. (grin)

Video Link

Jim Brown