MarketView for October 5

 

 

Summary 

 

What a day it was on Wall Street on Tuesday as share prices hit close to a five-month high, the result of growing conviction that the world’s central banks will do even more to bolster struggling economies worldwide. For example, the Bank of Japan lit the fuse overnight when it unexpectedly cut rates closer to zero and said it would pour money into the markets through asset purchases. This move came as markets increasingly believe the Fed will follow in a like manner. In fact, a top Fed official said in an interview published on Tuesday that the central bank should do "much more" monetary easing to spur a sluggish economic recovery.

 

With the probability of a quantitative easing by the Fed rising, commodity prices were higher, while resource stocks sent the S&P 500 through the 1,150 resistance level. If the 1,150 level holds, the next resistance level for the S&P 500 is seen around 1,170 to 1,175.Crude oil hit a five-month high near $83 per barrel and gold hit another record high of $1,341.20 per ounce.

 

The Bank of Japan set the positive tone early on after it cut its overnight rate target to virtually zero and pledged to buy 5 trillion yen ($60 billion) worth of assets in a fresh dose of economic stimulus. Additionally, Australia's central bank left interest rates steady for a fifth month, thwarting expectations of a hike.

 

Finally, the Institute for Supply Management's index showed the pace of growth in the U.S. services sector accelerated more quickly than forecast in September, while hiring also picked up. Industrial shares also ranked among the day's winners, with Dow components Boeing up 3.4 percent at $68.60, and Caterpillar up 2.8 percent to close at $79.40. Walgreen gained 2.6 percent to close at $33.98 after the chain posted an unexpected increase in September same-store sales.

 

Unexpected Growth in the Service Sector of the Economy

 

Growth within the service sector of the economy accelerated more quickly than economists had expected last month and hiring increased, according to a report released by the Institute for Supply Management on Tuesday. The increase in the ISM services sector index rose to 53.2 in September, from 51.5 in August. As a result, there was increased that economic activity had increased during the third quarter. A reading above 50 indicates expansion in the sector. Furthermore, this sector accounts for two-thirds or more of U.S. economic activity.

 

The index also indicated that services firms took on more workers in September, with the employment component rising to 50.2. Though that reflected only modest hiring, it was above the August reading of 48.2, which shows the sector shed jobs that month. New orders rose to 54.9 from 52.4. However, the ISM report's subcomponent business activity or production index slipped to 52.8, its lowest level since January, from 54.4.

 

Republican Party candidates argue that the billions of dollars in stimulus spending have failed to jolt the economy back to life and are calling for trimming record government budget deficits. Yet, an increasing number of economists and investors say any move toward cutting spending and trimming the fiscal deficit will plunge the country deeper in to the economic doldrums.

 

In an op-ed published in the London Financial Times newspaper on Tuesday, billionaire investor George Soros said there was "a strong case for further stimulus," adding "to cut government spending at a time of large-scale unemployment would be to ignore the lessons of history."

 

Federal Reserve officials have indicated that they may resort to pumping more money into the economy, likely via purchases of government and mortgage-backed bonds, if the economic outlook doesn't improve.

 

Fed's Evans Favors Increased Easing

 

The U.S. Federal Reserve should do "much more" monetary easing to spur a sluggish economic recovery," Chicago Federal Reserve Bank President Charles Evans said in an interview published on Tuesday.

 

"In the last several months I've stared at our unemployment forecast and come to the conclusion that it's just not coming down nearly as quickly as it should Evans told the Wall Street Journal.

 

"This is a far grimmer forecast than we ought to have," he said, for which reason he favors "much more accommodation than we've put in place."

 

The U.S. unemployment rate in August ticked up to 9.6 percent, and government figures to be released on Friday are expected to show a further increase to 9.7 percent.

 

Evans, who rotates into a voting position on the Fed's policy-setting committee next year, stands on the dovish end of the spectrum at the Fed, concerned more with high unemployment than with the threat of inflation. That puts him in the company of the most influential members of the committee, including New York Fed President William Dudley, Board Vice-Chairman Janet Yellen and Chairman Ben Bernanke.

 

Dudley's comments last week that he favored more accommodation unless the economy improves substantially were widely taken by market participants as a virtual promise of action at the Fed's next policy-making meeting, on November 2 and 3.

 

Many analysts expect the Fed to boost bond purchases at that time, despite recent public comments from some officials critical of the idea, including Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser.

 

Evans said he favors more asset purchases but worries that that alone would not be enough, the Journal reported. He said the Fed should consider ways to push inflation higher in order to bring down the real cost of credit.

 

The Fed might aim to overshoot its informal 2 percent inflation target for a time to make up for lost ground, he said, according to the Journal. Dudley has also suggested the Fed consider this tool, known as price-level targeting.

 

"That is a potentially useful policy tool at this point and I definitely think we should study it more," Evans said.

 

"It seems to me if we could somehow get lower real interest rates so that the amount of excess savings that is taking place relative to investment is lowered, that would be one channel for stimulating the economy," he said.

 

Stiglitz Wants Additional Fiscal Stimulus

 

Ultra-loose monetary policies by the Federal Reserve and the European Central Bank are throwing the world into "chaos" rather than helping the global economic recovery, Nobel Prize-winning economist Joseph Stiglitz said on Tuesday.

 

A "flood of liquidity" from the Fed and the ECB is bringing instability to foreign-exchange markets, forcing countries such as Japan and Brazil to defend its exporters, Stiglitz said.

 

"The irony is that the Fed is creating all this liquidity with the hope that it will revive the American economy," Stiglitz said. "It's doing nothing for the American economy, but it's causing chaos over the rest of the world. It's a very strange policy that they are pursuing."

 

The U.S. dollar has weakened about 6.5 percent against a basket of major currencies since the beginning of September as prospects for further monetary easing by the Fed have led investors to seek higher returns elsewhere.

 

That flow of dollars caused currencies to appreciate in many emerging market countries such as Brazil, which offers strong growth prospects. The Japanese yen has also hit record highs against the dollar on expectation of additional greenback weakness.

 

Recent actions by those countries to curb the strength of their currency were "necessary," Stiglitz added. "It's natural in that context for them to say -- we can't just let our exchange rates appreciate and destroy our exports," he said.

 

On Monday, Brazil doubled a tax on foreign investment into local government bonds, while Japan lowered the target for its benchmark interest rate to a range between zero and 0.1 percent.

 

The Bank of Japan also pledged to buy 5 trillion yen ($60 billion) worth of assets, in a strategy similar to the one adopted by the Fed to pump funds into the economy.

 

But additional monetary stimulus will "clearly" not solve the problems caused by lack of global aggregate demand, Stiglitz said.

 

"Lowering the interest rates may help a little bit, but that's much too weak to address the problems facing the United States and Europe," Stiglitz said. "We need fiscal stimulus."

 

Forex Flexibility Needed

 

Letting currency exchange rates adjust in response to market conditions is critical for rebalancing global growth and will be on the agenda when finance chiefs meet on Friday and Saturday, a senior U.S. Treasury Department official said on Tuesday.

 

"It's vital to achieve more balanced global growth. That's why the United States has been working to address distortions in the pattern of global growth," the U.S. official said, adding that "market-oriented exchange rates are included in the set of policy tools that are vital to achieving that rebalancing."

 

This weekend's semi-annual meetings of the International Monetary Fund and World Bank take place against a background of heightening worry a round of competitive currency devaluations may be occurring with the potential to trigger a currency war.

 

Finance ministers and central bankers will gather for Saturday and Sunday's semiannual meetings of the IMF and World Bank. On Friday night, finance ministers from the Group of Seven wealthy nations hold a dinner where currency practices are likely to be up for discussion.

 

The G7 consists of the United States, Britain, France, Germany, Italy, Canada and Japan, so its membership includes many of the top economies, with the exception of some key emerging-market countries like China, Brazil and India, who are not represented in the G7.

 

China has run huge trade surpluses with the United States in recent years, drawing the ire of U.S. lawmakers who said Beijing's refusal to let its currency rise gave it an unfair advantage. China agreed in June to let the yuan, also called the renminbi, react more freely to market forces. But since that time its value has only gone up about two percent, an indication that it remains in a tightly managed float.

 

Meanwhile, Japan has intervened in currency markets to drive its currency's value down and, on Monday, Brazil doubled a tax on foreign investors buying local bonds to 4 percent to curb a strong real that has risen because of a commodity boom and relatively high interest rates.