The FOMC minutes revealed the Fed was done spiking the punch and partygoers needed to sober up.
The FOMC minutes delivered an electric shock to the market that knocked the Dow down about -130 points at the lows before cooler heads prevailed. The minutes showed the FOMC was moving away from additional stimulus in the form of QE3 and possibly even closer to a rate hike than previously expected. The market was not happy.
The minutes offered plenty of conflicting opinions but it appeared the doves, those in favor of further stimulus, were in the minority. The Fed is adopting a wait and see attitude but emphasized the "no change in rates until 2014" commitment was dependent on the economy and could be changed at any time. It was never a commitment but a forecast but of course the market took it as etched in stone.
The Fed believed the gains in the job market could be temporary. They discussed the recent job gains as spurred by the warmer winter weather that pulled hiring forward and future months would suffer. They were concerned growth in jobs was faster than the growth in GDP and was unsustainable. This makes the payroll reports this week even more critical.
The Fed did revise its GDP estimates slightly higher and suggested there could be further upward revisions. They based that on higher equity prices and the resulting wealth effect and better growth overseas. They were pleased with the policy changes implemented overseas and the resulting decline in financial stress.
They were concerned about the higher oil prices but felt the impact was temporary and priecs would decline in the second half of the year. Higher oil prices did force the Fed to raise their inflation expectations slightly.
Their risks to slower growth were ironically the potential for fiscal tightening in the U.S., weak housing market and further household deleveraging.
The comments causing the markets to tumble were change in the tone of the FOMC. Instead of "several" members wanting to add further stimulus it changed to "two" members. Implementing a new QE3 program would need more than two members.
It appeared that those in favor of moving towards a tighter monetary policy had grown. Now it appears operation Twist will be allowed to expire in June. That was the selling of $400 billion in short term treasuries and buying a like amount of longer term treasuries.
The FOMC seems to have fractured into three groups. A minority is in favor of continued stimulus to stimulate job growth and insure the recovery continues. A few believe there is no need for additional stimulus and want to wait and watch future economic conditions before making any decisions. These few are not specifically opposed to more stimulus but ONLY if the economy begins to falter. The last group is adamantly opposed to further stimulus, believes the current monetary policy is too lax and favors taking action to begin the process to higher rates in the 2% range.
With the FOMC fractured into these three components it appears additional monetary stimulus is dead in the water unless economic growth slows. Similarly the hawks don't have enough support to change the current policy other than allowing Twist to expire.
The market did not like the balance of the FOMC shifting away from QE3 even though there is no sign of any tightening. Most Fed watchers plus Bernanke and SF Fed president John Williams, believe letting Twist expire would be the equivalent of policy tightening. Williams said today "the Fed must continue to act vigorously to boost the economy and sustain labor market gains. We are far below maximum employment and are likely to remain there for some time," Williams said in the text of remarks given today in San Diego. "Under these circumstances, itâ€™s essential that we keep strong monetary stimulus in place."
With the next FOMC meeting a two day event starting April 24th, and the last meeting the FOMC can take action before the election without it appearing blatantly political, we can expect all the Fed presidents and FOMC members to ratchet up their policy arguments in speeches and op-ed articles. There will be a serious headline battle over the next two weeks ahead of the meeting.
The FOMC minutes had multiple impacts on the market. Treasuries were sold off hard, the dollar rocketed higher, commodities collapsed and equities declined sharply.
With operation Twist apparently expiring in June the treasury market collapsed. Without the Fed buying $50-$60 billion of treasuries every month the price of treasuries will decline and yields rise. The Fed has been artificial support for the treasury market for the last three years. If they quit buying the market will be left to fluctuate and find its own level. The yield on the ten-year note shot up +4% on the news. If this continues it will harm the housing market that has been improving on the strength of record low mortgage rates.
Ten Year Yield Chart
The dollar also rocketed higher on expectations for higher interest rates and a stronger economy as represented by the Fed's upward revision in the GDP. The sharply stronger dollar immediately crushed any dollar denominated commodity such as gold.
Dollar Index Chart
Crude oil was caught in the middle between the stronger dollar and the upward revisions to the GDP forecast. Growth vs dollar and stronger dollar won to push prices lower. However, support on WTI held. Brent crude was less impacted because of recent events in the North Sea that have cut production significantly over the last two weeks. BP shut down a rig for maintenance and Shell has a group of rigs offline for a gas leak. Other companies are also in maintenance mode and that has cut 4-6 tanker loadings from the expected output over the next four weeks.
The API crude inventory report out after the close showed a gain of +7.8 million barrels over the last week. That was roughly in line with the gain reported by the EIA in their last report. The two inventory surveys have different cutoffs and methodologies. Gasoline inventories declined -4.5 million barrels.
WTI Crude Chart
Brent Crude Oil Chart
Gold prices were the hardest hit of the commodities with a -$32 drop to $1648. Gold has been struggling to rebound from the support at the $1640 level for several weeks. The major brokers like Merrill Lynch and Morgan Stanley are still expecting gold prices at $2000 over the next 12 months so this is a commodity waiting for a catalyst to appear.
The market was already weak before the FOMC minutes were released. The vehicle sales for March came in lower than expected at 14.4 million compared to a pace of 15.1 million in February. The Q1 average was 14.5 million units and the best quarter in four years but the sharp decline in March was unsettling. With the warmer weather there should have been more sales although there were 1.4 million units sold in March.
Sales are being driven by pent up demand after several years of frugal budgets and worry over jobs and the economy. GM did say they sold more than 100,000 fuel efficient cars with mileage over 30 MPG in March and suggesting there is a definite switch in progress away from the SUV consumer. Ford sales rose +5%, GM +11.8% and Chrysler +34%. Chrysler is debuting the new Viper this week. The production of the 10-cyclinder sports car was halted in 2010 as a result of the recession and the Chrysler bankruptcy. The Viper is what is referred to in the industry as a "halo" car. People flock to see the Viper and end up buying some other Chrysler product.
The average vehicle age in the U.S. is now 10.8 years and that should shrink as the economy picks up speed. Subprime loans in the auto sector have increased from 24% during the recession to 30% today. Tax refunds are expected to increase vehicle purchases in April and probably had a decent impact on March sales.
Moody's Vehicle Sales Chart
Offsetting the lower vehicle sales was a positive Factory Orders report for February. Orders rose +1.3% compared to a -1.0% drop in January. Expectations were for a gain of +1.5%. Durable goods rebounded strongly from -3.5% in January to +2.4% in February. Nondefense capital goods jumped from -3.4% to +1.7%.
The ISM for New York rose sharply to 551.8 from 543.1 and the largest monthly increase since February 2011. The current conditions component rose from 63.1 to 67.4. The six month outlook rose from 77.3 to 79.5.
More than 20% of survey respondents said a lack of qualified applicants was keeping them from hiring more workers and expanding their business. That is up from 17% in February and 16% in January. More than 58% of all businesses surveyed are in hiring mode. Less than 20% are still in a hiring freeze and the lowest percentage in four years. Employment in New York City hit an all time high in January that exceeded the pre-recession peak and the prior high in 1969.
Tomorrow starts the payroll reporting cycle for March with the ADP report. Analysts expect the ADP report to show a gain of +220,000 jobs compared to +216,000 in February. The Nonfarm Payrolls on Friday are expected to show job gains of +201,000.
Also on Wednesday is the ISM services report. Analysts are expecting a slight decline to 57.0 from 57.3. The ISM Manufacturing report on Monday showed a decent gain to 53.4 from 52.40.
ISM Manufacturing Chart
In stock news Apple (AAPL) received new target prices by two analysts at $1,000. Piper Jaffray analyst Gene Munster raised his price target to $1,000. Topeka Capital analyst Brian White garnered headlines by putting a $1,001 price target on the stock. White expects to see that price in 2013 while Munster thinks it will be there by 2014. Munster has a $910 target for 2012. Both analysts believe Apple will continue to gain market share with its products in the global market. Apple also has a new TV product coming out later this year. Apple shares hit $632 intraday.
Are we in bubble territory on Apple. When analysts are racing each other to but significantly higher price targets on the stock like $1,001 in order to get the most attention does that qualify as signs of a bubble?
In a note to investors Munster said a recent survey found that 40% of students plan on buying an iPhone in the next six months while 19% of non-tablet owners plan on purchasing a tablet in the same period. In the same survey the 34% of students that already owned a tablet, 70% had iPads, 19% Android and 11% Kindle Fires. Of the 19% who wanted to buy a tablet, 80% wanted an iPad. The survey polled 5,600 students.
A different survey by ComScore found that Blackberry market share of the smartphone market had declined to 13% while Apple had 30% and Google's Android had more than 50.1%. The Android share gained +3.2% in survey period. Microsoft's share declined -1.3% to 3.9%. ComScore said 104 million people in the U.S. owned a smartphone.
Research in Motion shares fell -9% after Gene Munster said they would eventually go to zero in an on air interview. The company was also hit with a patent suit by NXP Semiconductors.
Amazon (AMZN) announced a video streaming service will be available on Sony's Playstation 3 gaming console beginning on Tuesday. The streaming video can be accessed from an app on the PS3 as part of an agreement that involves the service being "prominently" featured on all consoles in the USA. Amazon instant video offers more than 120,000 movies and TV shows to buy or rent. They compete with Netflix. Amazon's streaming has not been available on game consoles until today while NetFlix has been available for some time.
The markets dropped sharply after the FOMC minutes were released but there was a buy the dip rebound. The S&P declined to 1404 but rebounded to close at 1413 and a loss of only -6 points. The 1405 level is initial support and it held. The next support level is 1390. So far the decline was just noise although the initial dip was pretty dramatic.
The first week of April is "normally" positive as retirement funds flow into the market. April has also posted an average of +4.5% gains over the last five years despite the market topping in the middle of the month over the last two years.
There is no material reason for the market to decline on the Fed news. Saying the GDP could be stronger than expected is not a bad thing. This is a knee jerk reaction to the news rather than a real change in the outlook. There was only a 50:50 chance of QE3 before the minutes and according to analysts that has not changed although the direction of the estimates will definitely begin to decrease.
The market will be telling us there is trouble when the 1390 support level breaks. Futures are down -2.50 after the close but there is a lot of darkness before morning. The ADP payroll report on Wednesday will be the next focal point and a strong number could erase the confusion over the FOMC minutes. A weak number would mean the FOMC might be more likely to move back towards accommodation mode. That means the payroll numbers are important.
The Dow declined to a low of -130 points on the FOMC news but regained +65 of those points. The critical Dow support at 13,000 is still 200 points below the close so there was no damage done. The Dow closed at the upper end of its three week range and there is no change in the trend.
Nasdaq Composite declined for 5th time in the last six days. The declines have been minimal and the close today was only -20 points from the recent high. Tech stocks continue to be the winners and like the other indexes the trend has not changed. Strong support at 3050 is well below the close at 3113 so there is plenty of room to chop around while we wait for earnings.
The Russell 2000 sentiment indicator is showing no signs of fund manager flight. The Russell is holding at the high end of its recent range. Until the Russell begins to breakdown the big cap market should remain stable. Watch the Russell for signs of trouble.
Russell 2000 Chart
We all knew there would come a day when the news from the Fed would force investors into a choice. This was not the day. This was simply a warning the day may be closer than previously thought. Once the Fed does tell us they are halting operation Twist the yields on treasuries will rise and value of those investments decline. That will force the fixed income investors to make a decision. Continue holding those bonds while the value declines or move into the equity markets to benefit from the economic recovery. The Fed can't justify allowing rates to rise unless the economy is improving. With the economy improving the place to be is in equities. When that day comes there is likely to be some initial panic but the long term outlook will be better.
That still does not prevent the normal seasonal market cycles like the sell in May and go away trade. Earnings are still expected to be weak so there will be plenty of people willing to take their profits and avoid the summer doldrums. The road ahead may be bumpy for the rest of the year but we can't wait patiently on the sidelines for 2013 to arrive. We need to be nimble and always keep an eye on the horizon for approaching storm clouds.
One down day does not make a trend.
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