FOMC Meeting Good For the Stock and Commodity Markets—Bad for the US Dollar

The FOMC in its two-day meeting that ended on Wednesday said that it would keep rates “exceptionally low” for an “extended period.” There has recently been market talk about when the Fed might drop its reference to keeping rates low for an “extended period” as a signal that the Fed is getting closer to raising rates. However, the Fed is clearly not close to considering a rate hike. The Fed is well aware that the during the Depression the central bank raised rates too soon and caused a renewed recession. The Fed is undoubtedly determined to ensure that the U.S. economy does not end up in a double-dip recession this time around.

The outcome of the FOMC meeting was in line with market expectations and there was little change in the federal funds futures strip curve following the meeting. The market is still expecting the Fed to keep its funds rate target unchanged at zero to 0.25% at the next three meetings on Dec 15-16, Jan 26-27, and March 16. However, the market is then discounting a 30% chance of a 25 basis point rate hike to 0.50% at the April 27-18 meeting and is fully discounting that rate hike by August 2010. The market is then expecting a slow rise in the funds rate to 1.00% by February 2011 and to 2.00% by August 2011.

While the markets are expecting the Fed to keep its funds rate target near zero until spring 2010, the market also expects the Fed to start slowly weaning the market off the exceptionally high levels of reserves that are in the banking system, which are currently still about $1.2 trillion above normal levels (see chart below). Last week the Fed completed its $300 billion Treasury purchase program, meaning that the Fed was at last finished with its quantitative easing program that in normal times is considered a cardinal sin against inflation. The end of that program in itself restored some of the bond market's confidence in the Fed. The Fed has also been discussing with dealers how it can conduct large-scale reverse repo operations to absorb liquidity when the time comes. However, over the near-term, the Fed’s largesse is likely to continue, thus supporting the stock market and the commodity markets.

The numbers below represent the Commercial Net Traders positions taken from the weekly Commitment of Traders (COT) report released by the Commodity Futures Trading Commission each Friday. You will find a 12-month high and low with the past 2 weeks of data. To see the past 52 weeks of commercial data please visit www.pricecharts.com. Simply open Analysis under the Resource category at the top of the screen and click on the Commercial Tracker on the left side selection menu. You will find this to be a very interesting presentation of the commercial COT information.

Commercial Net Tracker instructions
This form tracks the Commitment of Traders (COT) data for the commodity futures market. This form "looks" at the most recent five weeks of COT data and provides visual indications of the data. A. If the current value is at a 12-month low, the cell will display a red/burgundy background. B. If the current value is at a 12-month high, the cell will display a green background. C. If the current value went from net negative to net positive, the cell will display a blue background (indicating a bullish condition). D. If the current value is both a 12-month high and also went from a net negative to a net positive, the background will be green. You should view the data with green backgrounds to determine if they also went from net negative to net positive.

To view the entire year of commercial data please visit www.pricecharts.com.

Fundamental:
The S&P 500 index corrected further to a one-month low from last month’s one-year high. That one-year high represents a 48% correction of the two-year plunge from the record Oct. 2007 high to March’s 13-year low. Bearish factors for stocks include concerns in the banking sector after comments from Jon Greenlee, associate director of the Fed division that regulates banks, that the banking system is “far from robust” as lenders still face threats from defaults on commercial real estate loans; and the prediction from Pacific Investment Management that the slump in U.S. housing prices is unlikely to end before the middle of next year as recent statistics that show a rise in home prices is being distorted by government efforts to reduce foreclosures.

Bullish factors include the greater-than-expected surge in the October ISM manufacturing index to a 3-1/2 yr high, the unexpected +0.8% increase in September construction spending, the largest gain in a year, and Deutsche Bank’s hike in its GDP estimates for U.S. economic growth in the second half of this year and next year, citing a “noticeable pickup in demand” from the most recent Q3 GDP report.

Earnings expectations for the S&P 500 are as follows, according to Thomson Financial: Q3-2009 (-17.5%), Q4-2009 (+214.9%), Q1- 2010 (+37.6%), Q2-2010 (+20.9%). S&P 500 annual earnings are expected at –7.9% in 2009 and +26.9% in 2010 (2008 -23.9%, 2007 -3.7%, 2006 +16.1%, 2005 +13.7%, 2004 +20.2%, 2003 +18.4%, vs. 25-year average of +8.6%). The S&P 500 forward P/E (based on forward-looking earnings) is at 16.9, well above the 5- year average of 15.3.

Legend:
CC  - consecutive closes
UTL - uptrend line
DTL - downtrend line

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