U.S. stocks gained good ground on Tuesday after S&P affirmed their credit rating on Greek government debt of BBB+ (they had threatened to lower that rating) and the EU signaled they’d sidestep “no-bailout” rules and provide emergency loans to that government.  The market rally accelerated in the afternoon after the Fed confirmed the rate on fed funds will remain floored for an extended period (yeehaw!) and provided the impetus for traders to push past that 1150 market on the S&P 500 – had been stuck there for three sessions.   The broad market sits at a new 17-month high.

Basic material, financials and industrial shares led the advance.  All 10 of the major S&P 500 sectors gained ground on the day, but consumer staples and health-care (the traditional area of safety)  along with telecoms were the laggards. 

And speaking of commodity-related basic material shares, the price of oil is back above $82/barrel this morning – call it a Bernanke bounce.  I’m watching for the price to breach $85, which hasn’t occurred since economic mayhem began in late 2008.  At some point the market is going to view higher energy prices as another noose around the consumer’s neck.  In quick order we could have both oil and stocks at fresh 17-month highs, both are unlikely to move higher in tandem for very long.

Sovereign debt default concerns eased again yesterday, here’s the ebb and flow we’ve been talking about, as European finance ministers laid out unspecific groundwork for a financial lifeline to Greece.  If Greece runs into trouble rolling their debt, EU officials will provide emergency loans as members pool funds.  The meeting didn’t provide an actual euro amount of these potential emergency loans. 

Market Activity for March 16, 2010

Import Prices

The Labor Department reported that import prices fell 0.3% in February (a decline of 0.2% was expected), following what was a downwardly revised 1.3% jump (previously reported at +1.4%) in the previous month.  The February decline was largely due to a 2.4% drop in imported crude prices.  Excluding petro, import prices rose 0.2%. 

Basically all of the components that showed a price decline last month were directly related to energy prices.  Fuels & lubricants dropped 1.9% for the month; petroleum prices were down 2.2%; prices on imported industrial supplies were down 0.8%.  However, not all energy import prices were lower as natural gas and coal rose 2.1%, up 16.3% over the past year.

On those components that registered major prices increases, paper products led the way with a 2.0% increase – this segment of the report is up 17% at an annual rate since August, surely driven by tariffs that Congress has levied on Chinese paper imports; building material import prices increased 1.9%.; prices of durable goods (those meant to last more than three years) rose 1.5%.

From a year-over-year perspective, import prices have jumped 11.2% as the figures are being compared to very depressed levels.  These y/o/y readings should ease in the back-half of the year. 

Housing Starts

The Commerce Department reported that housing starts fell 5.9% in February to 575,000 units at a seasonally-adjusted annual rate (SAAR) after January’s activity was revised up to 611,000 from the initially reported 591,000.  The market expected builders to break ground on 3.6% less units, but expectations were skewed by that higher revision in the previous month. 

So housing starts were up 6.9% in January but down 5.9% in February.  As a result, starts are virtually unchanged from where they ended the previous quarter, and unless this latest figure is revised higher, or March posts a big gain, then residential construction is not going to provide a boost to first-quarter GDP.  Then again, as construction activity has tumbled and resides near record lows, housing only accounts for about 3% of GDP, so either way it goes it won’t have much effect on the economic growth figures. 

Building permits, a gauge of future construction, fell 1.6% in March after dropping 4.7% in February.  We certainly don’t need more houses right now as sales remain weak due to a high level of joblessness and the market must deal with an inventory of foreclosures that will hit the market for some time still – so the low level of housing construction is a necessary condition.  Yesterday the National Association of Home Builders reported their “prospective buyers” survey remained all but floored in March, so at least in terms of new homes sales we shouldn’t expect a bounce when the official figures are released at the end of the month. 

FOMC Statement

Well, my musings yesterday that the Fed may tweak their statement to change from the “extended period” (with regard to keeping the federal funds rates at exceptionally low levels) to something closer to “for some time” in order to prepare the market for an eventual gentle increase in their benchmark rate were premature.  They kept that “exceptionally low” for an “extended period” statement in place. 

The change in the language will come, but it is unlikely to occur with the jobless rate at 9.7% (and the Fed knows it’s likely to go higher in the ensuing months), a housing market that remains extremely weak, and banks that still need their interest income subsidized -- the rock bottom rates on the short-end of the curve are subsidizing bank profits at the expense of the saver.  Maybe they believe it was too much for the market to bear to have their MBS purchases coming to an end in a couple of weeks and a change in the language at the same time – I hope so, for if they don’t change it soon, the longer they drag this out, the harsher the market reaction may be.

Thomas Hoenig, president of the KC Fed Bank, was the sole dissenter for the second-straight meeting.  He’s not even saying to gently raise rates, just to change the language and change the market’s expectation of how long short-term rates will remain floored.  He’s concerned that in keeping the current language it “could lead to the buildup of financial imbalances and increase risks to longer run macroeconomic and financial stability.”  (He’s talking about the misallocation of resources as traders game Fed policy.)

What does the Fed know that they can’t muster a consensus to even change this language, much less get fed funds back to just 1.00%?  I contend they know there are more loan problems for the banks in the months ahead, the stock market (the main reason household net worth has improved) will not respond kindly to a signal of higher rates to come, and they fear the increase in servicing government debt via higher rates. 

Happy St. Patrick’s Day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900