MarketView for February 17

 

 

 

Summary 

 

Stronger-than-expected corporate results and upbeat economic data sent the major equity indexes higher on Wednesday on expectations that corporate profits are definitely on the mend. Deere & Co led the markets after its results beat expectations and it raised its outlook for the year ahead. Deere closed up 5 percent at $56.48.

 

The optimistic outlook on the economy was underpinned by data showing a six-month high in housing starts and a rise in industrial production in January. The results follow the upbeat trend in fourth-quarter U.S. corporate earnings, with more than 70 percent of the Standard & Poor's 500 companies beating analyst estimates so far, according to Thomson Reuter data.

 

Keeping up with the trend, technology bellwether Hewlett-Packard posted results after the closing bell which were better-than-expected and raised its full-year outlook. HP rose 0.5 percent to $50.60 in after-hours trading.

 

Healthcare stocks were among the biggest gainers during regular market hours as health insurance providers rebounded from recent declines. WellPoint Inc rose 2.1 percent and Aetna Inc jumped 3 percent.

 

United Technologies shares were up 2.2 percent to $67.35, after the company's chief executive said orders from China were not slowing despite that country's efforts to curb lending. The CEO also hinted of a possible stock buyback.

 

Shares of Whole Foods Market rose 12.6 percent to $34.35 after the supermarket chain posted a stronger-than-expected quarterly profit and raised its full year outlook. Walgreen edged up 0.3 percent to $34.19 after it said it will buy Duane Reade for $618 million in cash.

 

Among the laggards were energy shares, which gave up some of the gains that led the market to its best day in three months on Tuesday. Exxon Mobil fell 0.8 percent to close at $65.76.

 

Latest Economic News is Upbeat

 

According to the latest report released by the Commerce Department on Wednesday, housing starts were up 2.8 percent in January to a seasonally adjusted annual rate of 591,000 units, reversing the prior month's weather-induced decline.  December's housing starts were revised upwards to 575,000 units from the previously reported 557,000. Compared to January a year ago, housing starts rose 21.1 percent, the largest increase since April 2004.

 

Single-family home starts rose 1.5 percent to an annual rate of 484,000 units after falling 3 percent in December. Starts for the volatile multifamily segment increased 9.2 percent to a 107,000-unit annual pace after rising 12.6 percent in December.

 

New building permits, which give a sense of future home construction, fell 4.9 percent to 621,000 units last month after rising to a 14-month high of 653,000 in December, the Commerce Department said. The inventory of houses under construction fell 2.3 percent to a record low 503,000 units last month, while units authorized but not yet started eased 0.9 percent to 94,300.

 

The housing market, which is at the core of the most painful economic downturn since the Great Depression, is crawling out of a three-year slump, supported by government programs. New home construction contributed to economic growth in the third quarter of 2009 for the first time since 2005. However, there remains some concern in the marketplace that with the Fed ending purchases of mortgage-related securities in the coming weeks, mortgage interest rates will rise, putting additional pressure on the still weak market.

 

Furthermore, even with mortgage rates near record lows, demand for home loans remains lethargic. Mortgage applications dipped 2.1 percent, while refinancing slipped 1.2 percent, the Mortgage Bankers Association said in a separate report.

 

In a separate announcement, the Federal Reserve reported that industrial production rose 0.9 percent, with manufacturing, mining and utilities all posting gains. Capacity utilization, a measure of slack in the economy, rose to 72.6 percent from 71.9 percent a month earlier, but was still 8 percentage points below the average from 1972 to 2009, the Fed said.

 

A separate report from the Labor Department showed import prices rose 1.4 percent in January, led by a jump in prices for natural gas and other fuels. Export prices gained 0.8 percent in January after a 0.6 percent rise in December.

 

White House Says Employment Picture is Stable

 

White House economic adviser Christina Romer said on Wednesday that the employment picture was stable, with job growth expected by spring. Speaking on ABC's Good Morning America, Romer also said she believes there is bipartisan support in Congress to preserve jobs by providing new assistance to state governments struggling with yawning budget deficits.

 

President Barack Obama has made job creation his top priority in 2010 in a bid to address public anxiety about high unemployment and prospects for a slow economic recovery.

 

"Right now the employment numbers look basically stable," Romer said days after the jobless rate for January fell to a five-month low of 9.7 percent, just below the psychologically important 10 percent mark.

 

"We think we're going to see positive job growth by spring," she told ABC.

 

Democrats in Congress, led by Senate Majority Leader Harry Reid, have unveiled a jobs bill that relies on tax cuts to drive employment growth.

 

The approach has been criticized in some quarters as being too small to aid job growth and lacking in assistance for state governments that are trimming payrolls to cope with fiscal problems.

 

Nonetheless, Romer appeared optimistic about the prospects for federal aid to states. "Senator Reid has made it very clear that the package he's talking about is one step," she said.

 

"And we anticipate as we go through, I think there is a bipartisan realization of just how much states are still suffering and how state fiscal relief could help to keep teachers and all of those people that are working in our state governments employed."

 

Fed Wants to Go From Buyer to Seller

 

According to the minutes of the last Open Market Committee meeting, several Federal Reserve policy makers want to begin selling securities as soon as the economy finds a footing, the Fed said on Wednesday. The minutes of the Fed's latest policy meeting in January suggested officials remain positive about the economy's prospects even as they worry about the impact of an elevated unemployment rate, which they see holding near the current 9.7 percent through 2010.

 

To combat the worst recession the Fed has bought more than $1.5 trillion in government and mortgage bonds to pump money into the economy. The minutes offered a window into the Fed's thinking on how best to withdraw the extraordinary stimulus it has provided, but also revealed substantial disagreement among officials on the timing and sequencing of exit steps.

 

"Several thought it important to begin a program of asset sales in the near future to ensure that the Federal Reserve's balance sheet shrink more quickly," the minutes of the January 26-27 meeting said.

 

Other policy makers, however, appeared worried that selling mortgage debt into a fragile market might drive up mortgage rates, compromising the housing sector's tentative stabilization.

At the January meeting, the Fed held its target for interbank overnight rates in a zero to 0.25 percent range and reiterated a pledge to keep rates extraordinarily low for "an extended period."

 

Kansas City Federal Reserve Bank President Thomas Hoenig dissented at the meeting because he was uncomfortable with the low-rate pledge. The minutes showed that he did not want to drop the vow altogether but simply tone it down.

 

There was no clear evidence in the minutes that his dissent had much sympathy within the Fed's policy committee, but Philadelphia Fed President Charles Plosser said on Wednesday the language could curtail the bank's wiggle room.

 

Underlying the internal discord on the Fed's exit strategy are fundamental differences in economic theory. Officials diverge on how much a weak labor market and the economy's untapped productive capacity will dampen inflation.

 

The minutes showed officials do not believe a pickup in underlying inflation is an immediate concern, although many voiced anxiety that commodity prices could rise as the global economy gains traction, sparking broader inflation.

 

The Fed's quarterly economic forecasts contained in the minutes were slightly more optimistic than projections released in November. Officials see GDP rising between 2.8 percent and 3.5 percent this year. Previously, the forecast range was 2.5 percent to 3.5 percent. GDP grew at an annualized 5.7 percent pace in the fourth quarter, but few analysts expect that to be sustained.

 

"In general, participants saw the upside and downside risks to the outlook for economic growth as roughly balanced," the minutes said. The minutes uncovered plenty of debate surrounding what steps, or series of steps, the Fed should take first.

 

Most officials favored reducing the supply of reserves in the banking system before actually nudging higher the interest rate the central bank pays banks on their excess reserves. Raising that rate would encourage banks to park excess funds at the Fed and take that money out of circulation for a time.

 

However, several feared steps to reduce reserves would be interpreted as the opening salvo of a tighter policy, and should only be undertaken when policy makers are almost ready to raise rates.

 

The Fed said it would be ready by early spring to use mortgage-backed securities it holds as collateral in reserve-draining operations, and be able to conduct these transactions with a broader range of financial institutions soon after.

 

The minutes also referenced the possibility of implementing a "corridor" system, where the discount rate the Fed charges on direct loans to banks would serve as a ceiling for short-term borrowing costs and the rate paid on reserves would provide a floor.

 

Investors are bracing for the Fed to raise the discount rate in the near future, widening the gap between that rate and the target federal funds rate -- the central bank's main economic lever. Officials narrowed that spread during the heat of the credit crisis. Officials agreed in January such a move would be appropriate soon.

 

Plosser Believes Fed Should Sell Sooner...Not Later

 

The Federal Reserve should sell its mortgage-backed securities holdings sooner rather than later as the economic recovery gathers steam in order to extricate itself from fiscal policy, Philadelphia Federal Reserve Bank President Charles Plosser said on Wednesday.

 

At the height of the 2008-09 financial crises, the Fed put in place a raft of emergency programs, including one to buy $1.25 trillion worth of securities backed by mortgages guaranteed by Fannie Mae and Freddie Mac. In the process, its balance sheet more than doubled to over $2 trillion.

 

"As the economic recovery gains strength and monetary policy begins to normalize, I would favor our beginning to sell some of the agency mortgage-backed securities from our portfolio, rather than relying only on redemptions of these assets," Plosser said.

 

"It will take some time for the Fed's portfolio to return to its pre-crisis composition, but we should begin taking steps in that direction sooner rather than later," he said.

 

Plosser, known as a "hawk" on inflation, is not a voting member on the Fed's policy-setting committee this year. He will rotate into a voting seat next year. Plosser said that the timing and speed of asset sales will depend on economic conditions, but that the Fed's balance sheet ultimately has to shrink.

 

"Obviously, the faster we do it the better, in some sense, but we have no desire to disrupt the mortgage market or tank the economy in the process, so it will have to be done delicately," he said. Sales could be done at a modest pace at first to test markets' ability to absorb the assets, he said.

 

Asked about the likely order of the Fed's exit from its emergency policies, Plosser said no decision had been made yet. However, he added, "I'm not opposed, and I'd even favor, shrinking the balance sheet before we raise rates. Ultimately, the balance sheet has got to get down."

 

In addition to its emergency lending during the crisis, the Fed cut benchmark interest rates to near zero in December 2008 and has pledged to keep them there for an extended period. One policymaker, Kansas City Fed President Thomas Hoenig dissented against the Fed's decision to continue to promise to hold interest rates ultra-low for an "extended period."

 

Plosser told reporters he was sympathetic to Hoenig's view that the Fed should change that language. "It does confine us in some ways. It creates expectations in the markets which is a problem," he said.

 

Plosser has been vocal in his unease about the Fed's extraordinary policies, saying lending to specific sectors of the economy blurred the line between fiscal and monetary policy. That, along with bailouts of individual firms, has opened the central bank up to attacks on its independence, he said.

 

"By making these unprecedented lending decisions -- and at times being less transparent than we could have been -- the Fed has opened itself up to criticism from various sources and has encouraged the idea that monetary policy decisions may be influenced by political or other special interests," Plosser said.

 

The Philly Fed president said he believes the Fed can withdraw its stimulus "without generating a serious risk of inflation in the intermediate to long term," but noted that "will require some careful and difficult policy choices." "Politicizing that decision-making process will not deliver the desired outcomes and runs counter to responsible and sound central bank practice," he said.