MarketView for June 14

Summary

The major equity indexes were lower on Friday on low volume to end their third negative week in four on lingering concern over whether the world's central banks will soon start to trim their stimulus programs. The uncertainty regarding the longevity of the monetary stimulus programs around the world has caused a considerable rise in volatility.

On the economic front, Thomson Reuters/University of Michigan's preliminary index on consumer sentiment fell to 82.7 in June after touching a near six-year high of 84.5 in May. June's reading was the second highest in the last eight months, suggesting Americans were far from gloomy about their long-term economic prospects.

The headline producer price index rose more than expected in May as gasoline prices rebounded, the Labor Department reported. But underlying inflation pressures remained muted, which could bolster the argument against an early pullback in the Federal Reserve's stimulus program.

Going forward, attention is now focused on the Fed’s policy-setting meeting and press conference scheduled for Tuesday and Wednesday of the coming week. There is a good possibility that Bernanke is going to try to calm the markets and with some indication that the Fed does not intend to cut back on QE3 in the immediate future and when it does the markets will ample warning.

Meanwhile, the unwinding of trades linked to central bank support has recently strengthened correlations between asset classes. The 200-day correlation between the S&P 500 and the Japanese currency stands at minus 0.91, near its strongest inverse correlation in more than four years. Bets against the yen, cemented on expectations that Tokyo will keep accommodative monetary policy in place, have been used to finance long positions in Wall Street equities. The dollar extended losses against the yen on Friday to fall more than 3 percent for the week, its largest such drop since July 2009.

For the week, the Dow Jones Industrial Average fell 1.2 percent, the S&P 500 slid 1 percent and the Nasdaq lost 1.3 percent. The Dow swung 161 points throughout Friday's session. Its 14-day intraday average range is now 193 points - the highest since December 2011. The CBOE Volatility Index rose 4.5 percent to end Friday's session at 17.15. The VIX is Wall Street's favorite measure of investor anxiety. Do not look for volatility to ease back until there is some definite direction as to what the Fed is going to do.

Financial stocks led the market's decline on Friday. Dow component American Express ended the day down 3 percent to close at $72.97 and led financial shares lower. The stock extended its weekly loss to 6.5 percent. JPMorgan Chase fell 1.9 percent to $53.13 after the bank said its private equity unit, One Equity Partners, will become independent and raise future funds from an external group of partners.

DuPont ranked as the Dow's second-biggest percentage decliner, falling 2.2 percent to $52.68 after a brokerage cut its price target on the stock following the company's second-quarter earnings pre announcement on Thursday.

In contrast with the market's downturn, shares of Groupon closed up 11.5 percent to $7.65 after an analyst's upgrade increased optimism about a recent strategy shift by the world's largest daily deal company.

Approximately 5.5 billion shares changed hands on the three major equity exchanges, a number that was far below the daily average so far this year of about 6.39 billion shares.

Economic Data Mixed

There were a number of pieces of economic data released on Friday with the overall picture being one of slow but continuous economic growth with inflation well below the central bank's 2 percent target. The reports come ahead of a Federal Reserve meeting next week where policymakers will discuss whether and when to start scaling back their $85 billion a month pace of bond buying.

Consumer sentiment edged off a six-year high in June while manufacturing output picked up a bit last month after two straight months of declines, again suggesting the economy remains on a moderate growth path.

Wholesale prices rose in May as gasoline and food prices rebounded, underlying inflation pressures were muted. According to Friday’s report by the Labor Department the producer price index, a gauge of prices received by the nation's farms, factories and refineries rose 0.5 percent in May after declining 0.7 percent in April. Excluding volatile food and energy costs, wholesale prices were up only 0.1 percent for the second consecutive month.

In the 12 months through May, the core PPI rose 1.7 percent, the same as in April and March. The overall PPI was also up 1.7 percent after rising 0.6 percent in the period through April. Wholesale gasoline prices increased 1.5 percent last after dropping 6.0 percent in April, boosting energy prices. Energy prices accounted for more than 60 percent of the rise in PPI last month.

A record jump in egg prices pushed up food prices by 0.6 percent. The cost of food had fallen by 0.8 percent in April. Egg prices accounted for 60 percent of the rise in the wholesale food index last month. An increase in light truck prices accounted for almost two-thirds of the rise in core PPI in May.

The Thomson Reuters/University of Michigan's preliminary index on consumer sentiment fell to 82.7 in June after touching a near six-year high of 84.5 in May. June's reading was the second highest in the last eight months, suggesting Americans were far from gloomy about their long-term prospects.

While households appear to be weathering tighter fiscal policy, helped in part by rising home prices, the factory sector has taken a beating from spending cuts. It has also suffered from a recession in Europe that is weighing on global growth.

In a separate report, the Fed said factory output edged up 0.1 percent last month after two back-to-back declines. Overall industrial production was unchanged, held back by a big drop in utilities output.

IMF Urges Changes to U.S. Spending Cuts

The International Monetary Fund urged the United States on Friday to repeal sweeping government spending cuts and recommended that the Federal Reserve continue a bond-buying program through at least the end of the year.

In its annual check of the health of the U.S. economy, the IMF forecast economic growth would be a sluggish 1.9 percent this year. The IMF estimates growth would be as much as 1.75 percentage points higher if not for a rush to cut the government's budget deficit.

The IMF cut its outlook for economic growth in 2014 to 2.7 percent, below its 3 percent forecast published in April. The Fund said in April it still assumed the deep government spending cuts would be repealed, but it had now dropped that assumption.

The IMF said the United States should reverse the spending cuts and instead adopt a plan to slow the growth in spending on government-funded health care and pensions, known as "entitlements." The Fund would also like the United States to collect more in taxes.

"The deficit reduction in 2013 has been excessively rapid and ill-designed," the IMF said. "These cuts should be replaced with a back-loaded mix of entitlement savings and new revenues." The IMF warned cuts to education, science and infrastructure spending could reduce potential growth.

While the Fund said total debt across all levels of government would likely decline after 2015, public finances are nevertheless on an unsustainable path due to an aging population and higher spending on health care.

The Fund recommended that the Fed keep up its massive asset purchases at least through the end of the year to support the U.S. recovery, but should also prepare for a pull-back in the future. The Fed is currently buying $85 billion per month of Treasuries and mortgage-backed securities in an effort to lower borrowing costs and spur employment growth. Lagarde said the IMF has assumed that the Fed would begin trimming bond purchases next year.

Speculation over when the Fed might start to pare back its bond buying has roiled financial markets recently. Fed Chairman Ben Bernanke stoked market speculation last month when he said a decision to pare the Fed's current pace of asset purchases might happen at one of the Fed's "next few meetings" if the economy looked set to maintain momentum.

Recent outflows from bond funds and the rise in volatility offer a worrying glimpse of how markets are likely to behave as the Fed works to scale back its enormous monetary stimulus. The IMF said unwinding the easy-money policies would likely present challenges, and it was key for the Fed to communicate effectively with markets. It also said the long period of low interest rates could have unintended consequences in the future, sowing the seeds of future financial vulnerabilities.