MarketView for July 17

Summary

The major equity indexes were in positive territory by the closing bell on Tuesday after a gloomy economic outlook by Federal Reserve Chairman Ben Bernanke kept alive views that the Fed may yet take further steps to stimulate growth.

Share prices and oil had both come under pressure earlier in the session, while the dollar rallied after Bernanke dampened hopes the Fed was moving closer to a third round of bond buying to bolster flagging growth.

However, the markets sharply reversed course as reactions to Bernanke's testimony before Congress changed. Bernanke’s comments on the economy, especially on the jobs market, suggested the central bank was leaving the door open for further monetary stimulus.

Bernanke said policymakers would consider a range of tools to further stimulate growth if it became clear the labor market was not improving or if deflation risks mounted. Bernanke also told the Senate Banking Committee the economic recovery was being held back by anxiety over Europe's debt crisis and the path of our fiscal policy.

Coca-Cola and Goldman Sachs joined the growing roster of S&P companies that exceeded earnings forecasts and helped send share prices higher.

The euro recovered from losses against the dollar in late trading as investors positioned themselves for the next round of testimony from Bernanke. He will address the House of Representatives Financial Services Committee on Wednesday, in the second day of his semiannual testimony to Congress.

The euro rose 0.2 percent at $1.2295. It had earlier hit a one-week high of $1.2315 shortly after the release of a survey in Germany which was not as weak as some had feared.

Spain sold 3.56 billion euros ($4.36 billion) of short-term debt, just above its target range, and debt costs dipped from a month ago, although they remained at high levels as investors speculated Madrid will ultimately need a sovereign bailout. Spain faces a tougher test on Thursday when it auctions up to 3 billion euros of medium- and longer-dated bonds, with its 10-year bond yields edging close to the 7 percent level widely seen as unsustainable for a country's finances.

The dollar index, which tracks the dollar versus a basket of six currencies, fell 0.1 percent to 82.993. The dollar gained 0.3 percent against the yen, to 79.10 yen, a day after dropping to a one-month low, after Japan's finance minister said the yen's rise does not reflect Japan's fundamentals and hinted that the government is prepared to intervene to stem excessive moves.

In commodities trading, Brent crude oil futures rose 63 cents per barrel to settle at $104.00 for a fourth straight day of gains. Domestic sweet crude ended up 79 cents at $89.22. Spot gold fell to around $1,585 an ounce.

Treasury prices fell with the benchmark 10-year Treasury notes down 11/32 of a point to yield 1.5061 percent.

Inflation Unchanged

According to a report released by the Labor Department Tuesday morning, the overall consumer price index rose 1.7 percent year-on-year in June after increasing by the same margin in May, thereby offering the Federal Reserve some leeway in considering whether to ease monetary policy further in order to aid the faltering recovery.

The Consumer Price Index fell 0.3 percent in May and June's reading was in line with Street expectations. Stripping out food and energy, inflation pressures were also benign. Core CPI rose 0.2 percent for a fourth straight month, the Labor Department said.

The data was the latest sign of tepid domestic demand and provided the Fed with room to maneuver as it weighs options to aid the economic recovery, which has slowed significantly in recent months. Minutes of the U.S. central bank's June meeting released last week showed the Fed was open to buying more Treasury bonds to spur the economy, but the recovery would probably need to weaken further for broad consensus among policymakers.

The economy grew at a 1.9 percent annual rate in the first quarter and estimates for the April-June period are converging around a 1.5 percent pace. However, Fed Chairman Ben Bernanke could shed more light on the outlook for monetary policy when he gives his semi-annual testimony before lawmakers at 10 a.m.

Last month, overall inflation was held back by a 2.0 percent drop in gasoline prices, offsetting a 0.2 percent rise in food prices. Gasoline prices at the pump have declined about 53 cents from their peak around $4 a gallon in April, easing some of the strain on household budgets amid stagnant wages.

Core consumer prices last month were lifted by apparel prices, which rose 0.5 percent, advancing for a fourth consecutive month. New motor vehicle prices gained 0.2 percent after increasing by the same margin in May. Prices for used cars and trucks were flat after three straight months of strong gains. The cost of medical care rose at its fastest pace since September 2010, reflecting big increases for hospital and doctors' services. There were also gains in the cost of tobacco and recreation. However, the price of airline tickets fell 2.5 percent. Housing costs were muted, with owners' equivalent rent advancing 0.1 percent in June after gaining by the same margin in May.

In the 12 months to June, core CPI increased 2.2 percent after rising 2.3 percent in May. This measure has rebounded from a record low of 0.6 percent in October and the Fed, which last month expanded its efforts to stimulate the economy, aims for inflation of 2 percent.

Even the Fed is Perplexed

The Boston Federal Reserve Bank again pushed for a cut in the central bank's rate for emergency bank loans in June while its Kansas City counterpart sought an increase, minutes of central bank board meetings showed. The Fed has kept the discount rate steady at 0.75 percent, following the recommendation of the other 10 regional Fed banks.

At its most recent meeting in June, the Fed decided to extend a program where it buys long-term debt to keep borrowing costs low by using the proceeds from shorter-dated securities so as to not increase the size of its balance sheet.

Many directors cited downside economic risks from strains in global financial markets and uncertainty over the course of U.S. fiscal policy, the minutes said. At the same time, some pointed to strong performance in the energy sector while others were encouraged by recent strength in housing.