MarketView for May 21

MarketView

 

Events defining the day's trading activity on Wall Street

 

Lauren Rudd

 

Wednesday, May 21, 2008

 

 

 

 

Summary

 

Wall Street fell sharply again on Wednesday as record-high oil prices and a bleak economic assessment from the Federal Reserve sent Wall Street into a deep funk over rising costs and a shaky employment picture. The Dow Jones industrial average chalked up its widest two-day loss since late February. Early in the day, share prices began a downhill slide on the surging price of oil, which breached $135 per barrel for the first time on the futures market Wednesday.

 

The stock market slumped further after minutes from last month's Fed meeting revealed that while policymakers expected sharply lower economic growth and higher unemployment later this year, inflationary risks are likely to keep the central bank from cutting rates again. Lower interest rates spur economic growth, but they also tend to accelerate inflation.

 

High commodities prices have also been a source of anxiety, as many retailers and credit card companies have noticed consumers paring back spending on discretionary items, including clothing and jewelry, to be able to afford such necessities as gasoline and groceries.

 

Meanwhile, the Fed's minutes suggest the central bank's two main priorities - making sure the economy is growing, and keeping inflation in check - are both going to be tough to achieve through monetary policy. That is a troubling prospect for investors hoping that the economy will bounce back in the second half of the year and that the central bank will be able to concentrate on controlling inflation.

 

Meanwhile, Treasury prices fell the yield on the 10-year Treasury note, which moves opposite its price, rising to 3.812 percent from 3.78 percent late Tuesday.

 

Crude oil was up $4.19 per barrel to settle at $133.17 per barrel on the New York Mercantile Exchange. That is about a $20 increase per barrel over the beginning of May. It passed $135 a barrel in after-hours trading. Strong demand from China, supply disruptions in Nigeria, the dollar's slump versus other world currencies, and political tension in the Middle East have been responsible for much of the upward pressure on crude prices.

 

The airline industry has been particularly slammed by the rising cost of oil. Citing high fuel prices, American Airlines said Wednesday it will start charging $15 for the first checked bag, reduce domestic flights and cut perhaps thousands of jobs.

 

Financial stocks took a hit Wednesday after Moody's Investors Service said it is "conducting a thorough review" regarding the possibility that computer errors incorrectly gave high quality ratings to certain debt securities that later sank in value.

 

The dollar fell against most other major currencies, while gold prices advanced.

 

The Fed Is Worried

 

The Federal Reserve on Wednesday reduced its economic growth forecast for 2008 and signaled that mounting concerns over inflation would make further interest rate cuts unlikely. The Fed cut its projection for 2008 growth to a scant 0.3 percent to 1.2 percent, down from the 1.3 percent to 2 percent it forecast three months ago. At the same time, the U.S. central bank said it expects inflation to remain "elevated" and unemployment to increase "significantly."

 

"Several members noted that it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term," the Fed said in minutes from its April 29-30 policy meeting.

 

Fed officials said that cutting benchmark interbank lending rates by a quarter percentage point to 2 percent at their last meeting was "a close call," reinforcing the impression that policy-makers may be putting further interest rate moves on hold.

 

The minutes showed a Fed increasingly concerned about inflation and anticipating sluggish growth for a while, but cautiously optimistic the worst of the most serious financial crisis in years has passed.

 

Given recent shocks to the economy, it could be years before growth rates and unemployment levels return to their optimal levels, the Fed said.

 

The economy has expanded at a sluggish 0.6 percent annual rate in both the last three months of 2007 and the first quarter of this year. At the same time, however, record high oil prices have pushed up energy and food prices, raising the consumer price index by 3.9 percent in the 12 months to April.

 

Policy-makers felt at their April meeting that the risks that growth could slow were more closely balanced than in the past by the risks that inflation could spike higher.

 

"Members were ... concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices and the fact that some indicators suggested that inflation expectations had risen in recent months," the Fed said.

 

Participants at the Fed's meeting were about evenly divided as to whether the risks to the inflation outlook were balanced or were tilted to the upside, the minutes said.

 

The Fed raised its forecasts for inflation to 3.1 percent to 3.4 percent in 2008 from its January 2.1 percent to 2.4 percent projection for the personal consumption expenditures index. It expects unemployment to rise to 5.5 percent to 5.7 percent for the year. The jobless rate was at 5 percent in March and employers had cut jobs for the fourth month in a row.

 

The Fed also warned that the risks to its scaled-down growth projection remain to the downside, particularly if house prices continue to slide lower.

 

"Participants saw little indication of a bottoming out in either housing activity or prices," the minutes of the meeting said.

 

Fed officials took some comfort from signs that fragile credit markets, which have been severely shaken by doubts about bad credit, appear to be on the mend.

 

"The generally better state of financial markets had caused participants to mark down the odds that economic activity could be severely disrupted by a further substantial deterioration in the financial environment," the minutes said.

 

Crude Prices Rise Sharply Once Again

 

Oil prices surged $5 to a record over $134 per barrel on Wednesday after a government report showed a surprise drop in crude stockpiles, reinvigorating fears of a supply crunch. The recent price rise means that the price of crude oil is now up more than 34 percent so far this year in a rally that has raised alarm bells in consumer countries like the United States, already hard-hit by a housing slump and credit crisis.

 

Weakness in the U.S. dollar encouraged Wednesday's buying spree by bolstering the purchasing power of buyers holding other currencies, dealers said. Domestic sweet crude settled up $4.19 per barrel at $133.17. London Brent settled up $4.86 per barrel at $132.70.

 

The U.S. Energy Information Administration reported that crude stockpiles fell by 5.4 million barrels last week, countering expectations for a build. The fall in weekly inventories intensified concerns that supply problems will persist for years as production falls short of growth in demand. Oil for delivery in December 2016 rose above $142 a barrel on Wednesday, making it the loftiest contract on the futures curve.

 

OPEC has blamed oil's rally on speculation and the weak U.S. dollar and has repeatedly rebuffed calls from consumer nations for more supply. OPEC's largest producer, Saudi Arabia, said last week it has raised production by 300,000 barrels per day, but only to offset production problems from other members of the cartel.

 

Small Rating Error At Moody’s

 

Shares of Moody's fell more than 13 percent on Wednesday, the largest one-day drop since becoming an independent company in 2000, after the rating agency said a computer snafu resulted in incorrect top ratings for complex debt. The Financial Times first reported a coding error resulted in wrong "Aaa" ratings for debt known as Constant Proportion Debt Obligations, known as CPDOs. Moody's shares fell over 13 percent to $37.95 in the largest one-day drop in the stock since it was spun off from Dun & Bradstreet in 2000.

 

A Moody's spokesman in New York said the rating agency is "conducting a thorough review" of its rating methods for European CPDOs specifically, due to the computer glitch. The review of its computer coding does not extend to subprime mortgage debt, collateralized debt obligations or corporate bonds, Moody's said.

 

Agencies like Moody's, Standard & Poor's and Fitch Ratings have been under pressure by investors, regulators and critics for the past year for incorrectly rating subprime mortgage debt. Losses from deteriorating subprime mortgage and repackaged debt have led to more than $400 billion of market losses, according to Fitch Ratings.