Markets Mark Time as They Await The Latest Fed Interest Rate Statement

After reaching record all-time highs recently, the major stock indexes have been treading water ahead of some very important events this week. Despite the fact that the S&P had the nerve to decline last week, its loss was extremely nominal, from 1692 to 1691.5, while the Dow and Nasdaq continued to push higher.

For the record, this marked the first weekly decline for the S&P after four straight higher weeks; but let us remember that it is still ahead by 5 percent for the month of July, which would be its best monthly performance since October 2011. At the same time, the Nasdaq is enjoying its strongest monthly showing in a year and a half.

There are a few potentially market-moving events on the horizon, two of which will take place today when the initial estimate for second-quarter GDP will be released. The consensus is for growth to have slowed to a 1 percent rate, which would be lower than the 1.8 percent advance that the U.S. economy showed during the first three months of the year. In addition, there will be much drama surrounding the results of the latest Fed meeting when the minutes are released at 2 p.m. today. The reason that this has the potential to move the markets one way or the other is that the central bank will give us its latest read on where they think the economy is headed, which means that investors will have to make guesses in terms of when they think the start of tapering of the current $85 billion a month stimulus package will be initiated. The current thinking is that some sort of pulling back from the stimulus package will come about in September, which would be at the meeting after this one.

One can argue ad infinitum about whether the perception of tapering is going to be perceived as positive or negative for stocks in the sense that if the Fed feels that the economy is strong enough to advance on its own, then it does not have to be force-fed to the extent that it has been for the past year through these asset purchases. On the other hand, the argument can also be made that it is precisely because of these stimulus efforts that the economy has moved ahead to the extent that it has, and therefore the weaning process could put things back into a slowdown. And so it goes, which means that it is incumbent upon Chairman Bernanke and other officials to assure the market that the economy is in good enough shape to move forward on its own.

The economic data released over the past week gave proponents on both sides of the argument ammunition to advance their cause, as July new-home sales rose to their highest level in more than five years with a gain of 8.3 percent, June durable goods orders rose more than expected at a rate of 4.2 percent, and the final U. of Michigan July Consumer Sentiment Survey was at its highest level in six years.

On the other hand, weekly jobless claims did rise by 9,000 to 343,000 and June pending home sales declined a bit from six-year highs the month before. So take your pick in terms of whether the economy is growing at a satisfactory enough rate for the Fed to scale back its stimulus efforts.

In addition to the first look at second-quarter GDP, another report that is going to influence the Fed’s thinking is this Friday’s July non-farm payrolls report, which is projected to show an increase of 185,000 positions, slightly lower than last month’s 195,000. In addition, the unemployment rate is expected to tick back down to 7.5 percent. Monthly job growth for the first six months of the year has averaged 202,000, so all eyes will be on this report to see if there has been a slowing or not.

Another issue at the forefront of investor thinking is the president’s selection of the new Federal Reserve Chairman when the second four-year term of Ben Bernanke expires on January 31. The White House has said that no decision has been made so far and no announcement is likely until the fall. The betting is that the choice has been narrowed down to former Treasury Secretary Lawrence Summers and current Fed Vice-Chair Janet Yellen.

This choice will be one of the most important economic decisions of the president’s second term and one with global implications because the chairman of the Fed directs U.S. monetary policy and makes decisions that influence the course of the world’s largest economy and thus other economies around the world.

There was a report that the president is leaning toward Summers over the consensus front-runner Yellen, influenced by a behind-the-scenes campaign led by former Treasury Secretary Robert Rubin to get him chosen. This set off a hornet’s nest of criticism, because both Rubin and Summers played significant roles in de-regulating the financial industry in the 1990s when they worked for President Clinton and many believe that this set the stage for the financial meltdown of 2008-2009.

A group of 20 Democrats in the Senate prepared a letter “strongly” urging the president to back Yellen due to her more than 10 years of experience at the Fed, giving her credit for identifying the threat posed by the housing bubble of 2006-2007.

The announcement of the president’s selection is almost certain to cause a reaction in the financial markets as investors contemplate what the new chairman might mean for U.S. monetary policy. In fact, some observers this past week attributed any selloffs to investor nervousness over this decision. The reason is that current Fed officials are debating the timing of any tapering of the current $85 billion a month stimulus programs now in effect, and there are some who are saying that the first announcement of a pullback from the current level will be made at the September F.O.M.C. meeting.

Therefore the President will have to make certain that his choice is announced in a way that does not undermine the authority of Mr. Bernanke, and that his decision provides assurance to the financial markets that the new Fed chairman will not make a sharp break from current and past policies.