MarketView for December 11

 

 

Summary  

 

Last September, the Fed cited the possibility of a hit to the economy if lawmakers didn't agree on a budget as one reason to maintain its $85-billion-a-month bond-buying program. The bipartisan budget agreement reached late Tuesday would end three years of political confrontations and fiscal instability in Washington that climaxed in October with a partial government shutdown. A vote in the House of Representatives could come as soon as Thursday.

 

A final Fed policy statement of the year is expected on December 18, at the end of a two-day meeting. The Fed's stimulus has been instrumental in a rally that has put the S&P 500 on track to close its strongest year in more than a decade. Meanwhile, the 25 percent rally in the S&P 500 so far this year served as a reason for traders to sell some equities and lock in gains. The benchmark index slid throughout the day.

 

In one of the few items of market-moving news on Wednesday, Costco's profit missed Street estimates because of higher stock-based compensation expenses and spending on technology. Its shares fell 1.2 percent to close at $118.57.

 

Laboratory Corp fell 11 percent to $88.25 after the medical testing company cut the lower end of its full-year adjusted earnings forecast. The stock of rival Quest Diagnostics ended the day down 5.8 percent, closing at $55.20.

 

MasterCard announced a 10-for-1 stock split and a new $3.5 billion stock-buyback program, and raised its quarterly dividend by 83 percent. The news drove the stock up 3.5 percent to close at a record $790.57. Shares of its competitor Visa rose 3.1 percent to close at a record $205.66, helping to limit the Dow's decline.

 

Joy Global forecast 2014 earnings below Street estimates after reporting a quarterly profit that fell short of expectations as miners cut spending. The stock fell 5.5 percent to $53.15.

 

Approximately 6.5 billion shares changed hands on the major equity exchanges, a number that was above the 6.04 billion share average trading volume this month, according to data from BATS Global Markets.

 

Stanley Fischer Slated to Replace Janet Yellen as Vice Chairman of Fed

 

Stanley Fischer, who led the Bank of Israel for eight years until he stepped down in June, has been asked to be the Federal Reserve's next vice chair once Janet Yellen takes over as chief of the U.S. central bank, a source familiar with the issue said on Wednesday.

 

Fischer, 70, is widely respected as one of the world's top monetary economists. At the Massachusetts Institute of Technology, he once taught current Fed Chairman Ben Bernanke and Mario Draghi, the European Central Bank president.

 

Yellen, the current Fed vice chair, is expected to win approval from the U.S. Senate next week to take the reins from Bernanke, whose term ends in January.

 

Fischer has held top-level posts at the World Bank and the International Monetary Fund, where he was credited with guiding Israel through the global economic crisis with minimal damage. For the Fed, he would offer the fresh perspective of an outsider yet offer some continuity too.

 

Fischer would arrive at a Fed that is navigating a return to normalcy after taking dramatic and unprecedented steps to emerge from the Great Recession of 2007-2009.

 

The Fed is now wrestling with a decision on when to scale back a huge bond-buying program that has sought to drive down long-term borrowing costs, and that has swelled its balance sheet to some $4 trillion.

 

As Fed vice chair, Fischer would have a strong hand in shaping policy. Yellen, who has been vice chair since 2010, was a driving force behind the Fed's adoption last year of an inflation target, an important policy milestone for the bank.

 

At an IMF economic forum on November 8, held in Fischer's honor, he suggested he is a strong believer in the effectiveness of the Fed's unconventional policies.

 

"It's very hard to reach the conclusion that the unorthodox measures are ineffective," Fischer said of the bond buying, acknowledging the policy is controversial.

 

"They appear to be effective and they essentially do that by working off either the provision of liquidity in markets where liquidity has effectively dried up, or by changing interest rates other than the central bank interest rate, for instance in markets where longer-term interest rates are determined," he said on a panel with Bernanke and others.

 

The Fed's seven-member board is depleted and risks thinning further. Elizabeth Duke stepped down in August, Sarah Raskin is set to leave for a job at the Treasury, and Bernanke is expected to depart when his term as chair expires January 31.

 

With Yellen set to move from vice chair to the top spot, some economists and investors had speculated that Jeremy Stein, a well-respected Fed governor and former Harvard professor, would be tapped to replace her. Some observers expect that he too could leave and return to Harvard if Fischer steps in.

 

Fischer, a naturalized American who was born in present-day Zambia, quit his job as head of Israel's central bank on June 30, three years into his second five-year term.

 

Asked about his next job at a conference in Tel Aviv on Monday, he said: "The advice I received was not to accept a position until I had waited at least six months which is in three weeks, so it seems like I am nearing a decision."

 

Once chief economist at the World Bank and then first deputy managing director of the International Monetary Fund from 1994 to 2001, Fischer was a key figure in the IMF's Mexican bailout after the peso crashed in the mid-1990s and the fund's main firefighter as it sought to douse the flames of the Asian financial crisis.

 

At the time, he negotiated repeatedly with troubled countries, jetting from one to the next as a financial storm swept through the world's emerging markets. Robert Rubin, the influential former U.S. Treasury secretary, once described him as the "unsung hero" of the crises.

 

During his tenure in Israel, the country's economy performed better than most. Despite a firm focus on fighting inflation, he slashed interest rates and went against his own policy of staying out of financial markets by buying up tens of billion of dollars to weaken the shekel and help prop up local exporters.

 

Fischer was a vice chairman of Citigroup prior to joining the Bank of Israel. He had sought the top job at the IMF in 2011 but was disqualified due to his age.

 

If Fischer is nominated and approved by the U.S. Senate in time to take the reins from Yellen as she ascends to Fed chair, it would be the first time in Fed history that the two top posts at the central bank are filled at the same time.

 

The closest to that the Fed has ever come was in 1979, when Paul Volcker took over as Fed chair less than two weeks after Vice Chair Frederick H. Schultz started his job.

 

How Much Will the Fed Actually Tell Us

 

The central question before the Federal Reserve is now when exactly will it pull back on its QE3 purchases and how much and when will it tell the investing public. While the recent economic data has raised the probability that the Fed might taper at their meeting next week, the consensus seems to be that the Fed to keep its $85 billion-a-month bond-buying program in place for several months yet.

 

However, the Fed is expected to grapple with the question of how much to communicate regarding its plans to wind down its purchases, and to reinforce its commitment to keeping interest rates near zero even as it preps markets for the long road back to policy normalcy.

 

"What should be on the table is, Are there adjustments to our forward guidance that would reinforce the overall stance of policy that the Fed is trying to communicate?" the president of the Atlanta Fed, Dennis Lockhart, who is often seen as a bellwether for overall monetary policy, told reporters last week.

 

To convince financial markets they are serious about supporting a recovery in the world's top economies, central banks have resorted to so-called forward guidance on interest rates in the wake of the Great Recession. Moreover, if you take central bankers at their word, the theory goes, borrowing costs should stay low enough to allow the economy to make up for lost ground. To pull our economy from its worst downturn in decades, the Fed has kept short-term rates near zero. At the same time it has pushed down long-term borrowing costs by buying trillions of dollars in Treasuries and housing-backed securities.

 

Layered on top of that approach is the forward guidance - a critical and relatively new element in the Fed's strategy to boost investment and hiring.

 

Since December last year, the Fed has promised not to even consider raising rates until unemployment falls to at least 6.5 percent. Less precise but no less important is the Fed's guidance on asset-purchases - it will keep buying until the labor market outlook improves substantially. Now that unemployment has fallen to 7 percent, from 10 percent four years ago, change is afoot.

 

The markets can handle a "small taper," St. Louis Fed President James Bullard, a policy centrist, told a group of investment advisers this week. Even the dovish chief of the Chicago Fed, Charles Evans, said in a recent interview he is "open-minded" to a reduction at the December 17-18 meeting.

 

One of the issues at the Fed’s meeting next week is to discuss the merits of adopting a preset schedule for winding down the Fed's third round of bond-buying since the recession, known as quantitative easing, or QE3.

 

Four Fed officials have publicly embraced this idea, arguing that doing so would allow markets to digest the policy change more easily. At least two, San Francisco Fed President John Williams and Charles Plosser of the Philadelphia Fed, want to put a cap on QE, which has already swelled the Fed's balance sheet to $4 trillion.

 

"I'm becoming more sympathetic to the view that once we decide, when we decide, our program has accomplished what we wanted it to do ... that maybe it would be good to announce kind of an end to the program at that point," Williams said in an interview last week. "I think we can do more work on our forward guidance."

 

As to when rates will finally rise, half of top Wall Street economists polled by Reuters believe the central bank will retool its low-rate vow to promise no rate hike until unemployment has fallen to 6 percent or lower.

 

The idea behind lowering the threshold would be to head off a bond-market selloff like that which occurred this past spring in response to hints that the end of QE was close. The selloff pushed long-term borrowing costs to potentially bruising levels and was one reason the Fed did not reduce QE in September.

 

Fed officials may ultimately shy away from such a move, in part because doing so could complicate an already complicated policy.

 

Instead, Fed Chairman Ben Bernanke could use stronger and more precise language to stress that easy policies are in place for a considerable period after unemployment hits the 6.5 percent threshold.

 

A gauge of core inflation closely monitored by the Fed rose just 1.1 percent over the year through October, well below the central bank's 2 percent target.

 

As the Fed looks set to tinker with its language, the debate over forward guidance rages globally.

 

The Bank of England, for one, has tied a possible rate rise to 7 percent unemployment. "We think it's been effective," BoE Governor Mark Carney said of the guidance on Monday. But "we don't sit here and think we need to reinforce it, except by ... repetition."

 

Some central bankers have lately cooled to offering precise guidance.

 

The head of the Bank of Japan, Haruhiko Kuroda, said last week that central banks should avoid offering overly complicated forward guidance on their policies, warning that doing so could prove counter-productive.

 

"Too complicated forward guidance, or too complicated communication," Kuroda said, "could be less efficient and sometimes even disruptive."