Stocks Rally on Upbeat Fed News; Optimistic Obama Speech

James Hyerczyk from ForexHound.com at 01/27/10

U.S. equity markets hemmed and hawed immediately after the FOMC announcement before rallying sharply higher.  Traders seemed to have had a delayed reaction to upbeat news from the Fed regarding the economy.  Although it kept interest rates unchanged and offered no hard evidence as to when rates were to begin rising, it did say that there were “moderate” rather than “weak” improvements in the economy.  This change in the statement may have given investors more confidence to buy stocks.

Tomorrow, traders will react to tonight’s speech by President Obama.  Investors are looking for more clarity as to how the government plans to regulate proprietary trading by financial institutions.  In addition, investors are likely to react to news about jobs stimulus and tax breaks for small businesses.

Treasury futures finished mixed after the Fed announcement.  Short-term rates rose as the FOMC statement may have brought the U.S. closer to higher interest rates. News that the economy was improving also encouraged investors to liquidate safe Treasury positions for higher risk stocks.

February Gold fell after the Dollar rallied following the Fed announcement.  Furthermore, the Fed’s statement that inflation was “subdued” offered no consolation to the bulls.  The chart pattern suggests that this market could be on the brink of a collapse of another $50 to $100.  The lack of demand from China and low inflation are two factors which could trigger speculative liquidation. The Dollar will have to top before gold puts in a bottom.

March Crude Oil finished lower on Wednesday. Oil reversed its earlier direction after a report showed that inventories rose. Demand for safer assets also pressured commodities and stocks. Investors are focusing on a possible slowdown in the global economic recovery which will lead to a drop in demand for petroleum products.

The U.S. Dollar rallied to a new high for the year after the FOMC announcement offered an upbeat assessment of the economy.

While just about everyone knew the Fed would keep interest rates unchanged at near 0% for a prolonged period of time, traders did take note of the change in its language when it said “the pace of economic activity is likely to be moderate for a time”. This was better news than the statement in December which read “economic activity is likely to remain weak for a time”.  Traders responded to this good news by sending the Dollar to its highest level since September 2009.

The Dollar also strengthened on the news that the Fed would end its mortgage buyback program as scheduled on March 31st. This news drove up short-term interest rates as traders assessed this action to mean the economy was improving enough to warrant a rate increase sometime after September. The FOMC did cover itself against future deterioration in the economy by saying that it “will continue to evaluate its purchases of securities in light of the evolving economic outlook”.

There was one dissenter present at the meeting. Kansas City Fed President Thomas Hoenig objected to the language of keeping interest rates low for a prolonged period of time. He may have felt the time was right for the Fed to own up to the improving economy rather than keep the market in suspense. What his dissention does reveal is that there may be regions or pockets in the economy recovering faster than others. Traders should watch for more commentary from Mr. Hoenig when the Fed Presidents hit the speaker circuit in the next few weeks.

The Fed also indicated that credit markets were improving when it announced the closure of four facilities supporting money markets and bond dealers. In addition, dollar swap programs initiated in 2009 were also tagged for closure.

While some may view these moves as aggressive, it still shows the Fed remains content with taking baby steps as it removes the training wheels from the economy. Concerns about employment and inflation still remain the major hurdles the Fed has yet to overcome.

In its statement, the Fed said, “Inflation is likely to be subdued for some time” and “information received since the Federal Open Market Committee met in December suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating”.  This means that the emphasis the next few months will be on the employment picture. The Fed will want to see a stronger trend developing in the jobs market before it can accept the fact that sustainable growth is taking place. By the time the Fed meets again on March 16th, it will have two Non-Farm Payroll Reports under its belt when it re-evaluates the employment situation.  This should give the Fed plenty of ammunition to make a more powerful statement should improvements in the economy warrant such a move.