MarketView for July 22

Summary

Share prices were substantially higher on Thursday, riding on the backs of large cap stock such as 3M, UPS and Caterpillar as Wall Street recalibrated its call on the strength of the economic recovery. Meanwhile, the parade of prominent names reporting higher earnings continued after the market's close. A good example was Microsoft, which reported a 48 percent rise in quarterly earnings. In regular trading its shares rose 2.9 percent to $25.84, but they were down 0.2 percent after hours. Amazon reported higher earnings but the number fell short of Street expectations, sending its shares down 13.5 percent to $103.88. Caterpillar closed up 1.7 percent to $68, and 3M chalked up a gain of 3 percent to close at $84.75.

During the regular session, the major indexes posted their largest daily gains in more than two weeks, led by UPS, which rose 5.2 percent after it raised its earnings outlook. The world's largest package delivery company is viewed as a barometer of consumer and business demand. Thursday's rally reversed losses from a day earlier after testimony by Federal Reserve Chairman Ben Bernanke whose testimony on the economic outlook deflated Street ebullience and sent shares sliding downward.

Nonetheless, the S&P 500 still failed to break through 1,100, a level that is proving to be a tough hurdle and could be in the way of further gains.

Among the day’s economic reports, the Labor Department indicated that weekly applications for unemployment insurance rose. Job growth has slowed after strong gains early in the year, cutting into household spending and holding back the economy's recovery from the toughest recession since the 1930s. Home re-sales declined less than expected but still hit a three-month low in June, while the median home sale price rose by 1 percent from the previous year.

The Federal Reserve reported that its M-2 money supply rose by $14.0 billion during the week of July 12 to $8,602.8 billion. The Fed said the four-week moving average of M-2 was $8,606.6 billion as compared to $8,602.1 billion in the previous week.

It All Depends on the Employment Numbers

The Fed may try to push borrowing costs even lower if the job market continues to languish, Fed Chairman Ben Bernanke said on Thursday, offering a hint of what might trigger additional monetary easing.

After three quarters of solid growth, the U.S. economy has been losing steam, with firms still reluctant to hire and the housing sector seemingly unable to exit a prolonged rut.

Bernanke's comments accompanied Labor Department data on Thursday showing new claims for state unemployment benefits spiked to 464,000 last week.

With fears of a "double-dip" recession mounting in recent weeks, Bernanke reassured lawmakers the Fed is prepared to take further steps if the situation worsens appreciably.

"We are ready and will act if the economy does not continue to improve, if we don't see the kind of improvements in the labor market that we are hoping for and expecting," Bernanke told the House of Representatives Financial Services Committee.

As he did before a Senate panel on Wednesday, Bernanke indicated the Fed does not expect the economy to stall, and therefore does not foresee any extra policy measures being needed.

Even with interest rates effectively at zero, Bernanke argued there is more the central bank can do if needed to spur growth. One possibility would be to lower the rate it pays banks to park excess reserves at the Fed, currently 0.25 percent. Asked by a legislator why the Fed continues to pay banks to keep their money idle despite weak lending conditions, Bernanke said cutting the rate carries risks.

"If rates go to zero there will be no incentive for buying and selling federal funds, overnight money in the banking system and if that market shuts down ... it'll be more difficult to manage short-term interest rates," Bernanke said.

Other options for the Fed include bolstering its stated commitment to keep official rates low for an "extended period," or purchase yet more debt, Bernanke said.

In addition to slashing interest rates to rock-bottom levels, the Fed bought more than $1.5 trillion in mortgage and Treasury securities in an effort to combat the deepest recession since the Great Depression.

However, under conditions of greater financial turmoil, the impact of its remaining policy options might be significant. "If financial conditions become more stressed, as would happen presumably if the economy began to weaken, I think those steps would be more effective relatively speaking," Bernanke said.

With unemployment still hovering around 9.5 percent, one legislator accused Bernanke and the Fed of not doing enough to address the problem. But Bernanke countered that the Fed had already done a lot.

"I absolutely agree with you that unemployment is the most important problem that we have right now," Bernanke said. "What we can do is make financial conditions as supportive of growth as we can and we certainly are doing that."

His testimony highlighted just how much of the Fed's near-term policy path hinges on a labor market that has remained stubbornly stagnant despite a better economic backdrop.