A Fed Fueled Rally
By Chris Maxey
September 17, 2012
A fed fueled Rally
The week was overshadowed by policy actions from the Federal Reserve, which led to a 2.2% gain in the Dow Jones Industrial Average and a 1.9% increase in the S&P 500 Index.
Consumers reentered the lens last week, with news on retail sales, sentiment and inflation offering insight into their current psyche. Hard data on spending showed a skeptical consumer, while improved sentiment figures suggested that they are feeling modestly better.
Retail sales for August posted a 0.9% increase, following a similarly strong 0.6% gain in July. For the past 12 months, retail sales are higher by 4.7%. On the surface, retail sales are quite healthy, but the underlying trend is not quite as positive.
Most of the gain was driven by gasoline sales, particularly given the roughly 20 cents per gallon increase in the cost of gas. After excluding the impact of motor vehicles and gasoline, retail sales showed a modest 0.1% gain. Weaker sales were apparent in merchandise and electronics. It was certainly a weak back-to-school period, but this may simply be the case of give back from a strong July report, in which retail sales ex gas and motor vehicles rose 0.8%.
Contrasting retail sales was an unexpected uptick in consumer sentiment. The consumer sentiment index jumped to 79.2 in August from 74.3 in the previous month. Most of the gain was the result of consumers taking a more optimistic view of the future. Consumers’ view of current conditions dipped 0.4 to 88.3 while the expectations index rose 8.3 points to 73.4.
Consumers may feel better about the recovery, but the reality shows that consumers are in no place to fully enjoy it. Recent analysis from the Pew Research Center found that median household income fell as much between 2009 and 2011 as it did between the recessionary years of 2007 to 2009.
Source: Pew Research Center
Similar surveys from Gallup reveal just how little has changed. Gallup’s Economic Confidence Index fell to -27 recently after reaching a high of -17 earlier in the year. The current reading is sharply improved from last summer, but the index remains mired at a depressed levels.
On the inflationary front, consumers learned that the steady rise in prices last year is beginning to taper off. The headline Consumer Price Index (CPI) jumped 0.6%, but excluding the impact of food and energy, prices were higher by just 0.1%. Consistent with the trend in retail sales, energy prices were up 5.6% in August on the heels of higher gas prices. Within the core, however, price changes were relatively muted. Weakness was broad based in the core as prices fell in the goods component and in airfares.
Producers underwent a similar fate in August as the Producer Price Index (PPI) rose 1.7%. Excluding food and energy, prices were higher by 0.2%.
Overriding all economic data last week was news from Germany and the U.S. Federal Reserve. In Germany, constitutional courts agreed to ratify the European Stability Mechanism. As expected, certain restrictions were tied to ratification, including parliamentary approval for German liabilities over €190 billion. Approval of the ESM removes another uncertainty from the market, which was clearly a bullish sign for risk assets.
Closer to home, the Federal Reserve took the somewhat unexpected step of extending Operation Twist by purchasing $40 billion of agency mortgage-backed securities per month until such time that the economy improves. In addition, the Fed extended its low interest rate stance until the middle of 2015, providing another guidepost for markets.
The Fed is clearly attempting to support the nascent housing recovery and provide peripheral support to a tepid labor market. These moves might prove ineffective later this year if Congress is unable to reach a compromise on the fiscal cliff, though. Such asset purchases provide a strong psychological message to markets, but the fiscal cliff presents a very real possibility of a 4% to 5% hit to GDP.
Further complicating the situation is recent announcements from ratings agencies Moody’s and Egan Jones. Moody’s warned that the U.S. credit rating could drop if leaders are unable to reach an agreement on the fiscal cliff. Egan Jones, on the other hand, simply went ahead and dropped the U.S. credit rating to AA-, citing the Fed’s new asset purchases as a detriment to the economy and credit quality. Ratings agencies are notoriously behind the ball, and markets generally ignore their opinion these days; nevertheless, these actions send a signal to the markets that, even though the Fed is acting, the economic situation continues to stagnate and long-term ramifications of QE are completely unknown.
the week ahead
It continues to be a busy environment, with a full calendar of economic data and several policy meetings.
Economic data to watch includes PMIs in China and Europe, the Philadelphia Fed survey, housing starts in the U.S. and the latest report on existing home sales.
In the world of central banking, markets will focus on meetings in India, Turkey, Japan, South Africa and Taiwan.
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