stock futures struggled a bit on Wednesday but were able to post their 7th
consecutive gain. Stocks were expected to trade sharply higher on the heels of
a strong earnings report from Intel but demand for equities faltered overnight
due to concerns about European bank stress tests and today following a weak
Retail Sales report. Late in the session, news that the Fed lowered its outlook
for the economy weighed on the markets into the close. Despite the negative news,
there were enough buyers in the market today to weather the storm. This was an
indication that the majority of investors are still focusing on earnings rather
than the economy. This could change, however, once investors assess the Fed
If todayâ€™s late session weakness is any indication, stocks
may have trouble rallying from their current positions if investors begin to
believe the Fedâ€™s outlook for lower GDP and employment. If traders maintain
their optimism because of earnings, then the reaction to the Fed may be
delayed. Either way, expectations are for this rally to become labored which
may be an indication that the bears are stepping up their activity.
The best topping sign to look for at this time is a closing
price reversal. This means that a new high for the week is necessary, followed
by a lower close.
The upside action in the Treasuries and the strong closes in
both the September Treasury Bonds and Treasury Notes is a strong sign that the
Fed is going to keep interest rates at historically low levels for a prolonged
period of time. Although stocks rallied today along with the Treasuries, one of
these markets has to give sooner or later. Since the Fed data supports a weaker
economy over a longer period of time than earnings, my assessment is that the
stock market rally will fade once traders realize the economy is not getting
It looks as if U.S. Dollar bears have a decision to make
after the Fed Minutes painted a gloomy picture of the economy. Either the
Dollar will decline because of the Fedâ€™s outlook or the Dollar will rally
because of renewed risk aversion.
For the past few weeks, worse-than-expected U.S. economic
reports have driven investors out of the Dollar and into foreign currencies but
this trend may becoming to an end as traders assess the Fedâ€™s new outlook for
Late Wednesday the Dollar began a small comeback following
the release of the June Federal Open Market Committee Minutes. In the report,
Fed officials issued an updated economic forecast calling for a downward
revision of the Gross Domestic Product. In April, the Fed pegged the GDP growth
rate at 3.2 percent to 3.7 percent. Todayâ€™s report showed a downward revision
of GDP to 3 percent to 3.5 percent.
The Fed also revised its forecast for the unemployment rate.
The rate, now at 9.5 percent, is projected to drop to 9.2 percent in the best
case scenario. In April, the Fed was calling for a decline to 9.1 percent.
Both downward projections paint a gloomy outlook for the
economy, reflecting worries about how the European debt crisis could affect U.S.
growth and job prospects. Traders have to remember that Europe
is in the midst of invoking financial austerity measures which are designed to
curtail spending. This could have a direct affect on demand for U.S.
goods and services leading to a drop in GDP and lower employment.
Although the Fed is projecting a decline in GDP and
employment, the Fed also saw less of a threat of inflation. The Fed predicted
that inflation would rise 1 to 1.1 percent, down from the April forecast of 1.2
to 1.5 percent. This change in inflation reflects an expected drop in consumer
Since the Fed is projecting low inflation, investors feel it
now has room to leave interest rates at historically low levels for a prolonged
period of time.
The key factors contributing to the decline in the economy
are household and business uncertainty, weak real estate markets, a weak job
market, diminishing fiscal stimulus and tight lending by banks.
Unlike Aprilâ€™s projections, this time â€śmostâ€ť Fed officials
felt that it would take â€śno more than five or six yearsâ€ť for the economy to
reach its goals for maximum employment with low inflation. Previously, only a
minority of Fed honchos thought it would take more than that time for the economy
U.S. Treasury markets rallied sharply higher following the
release of the Fed minutes, indicating fixed income investors are looking for
yields to fall further. This move could be indicative of the start of another
flight rally into the Dollar.
With the Euro currently toying with a major 50% level at
1.2783, this spot on the chart would be the perfect spot for the start of a
correction. Furthermore, with less than ten days until the release of the
European bank stress test results and rumors afloat that eleven or more banks
may have failed the test, now would be the right time for the Euro to begin to
Todayâ€™s Fed report may have taken the spotlight away from
earnings season for the time being. A clash between those who want to sell the
Dollar because of better than expected earnings and those who want to buy the
Dollar because of renewed risk aversion may be on the horizon. This conflict
between the two forces could trigger volatile conditions over the near-term
with sudden shifts in direction. Itâ€™s hard to predict at this time which way
the trend will develop, but what is clear is that traders are in for a rocky
time in the markets over the short-run until one of the forces takes control.
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