U.S. stocks failed to build on Tuesday’s rally for a second session.  The broad market began the day higher but slid mid-morning and a late-session rally wasn’t enough pull the S&P 500 back to positive territory. 

I noticed Bloomberg News cited questions over whether the Fed will pursue additional stimulus measures (QE2) as the reason for yesterday’s slight pullback – I guess some saw a dip in jobless claims as reason to raise this question, but that’s a pretty silly assumption as 445K in initial jobless claims and 9.5 million in continuing claims hardly suggests a labor market on the mend.  Besides, after the Fed has set the market expectations up for significant levels of additional monetary easing it’s not going to be pretty if they pull the rug out now – they’re boxed in at this point.

Tech, consumer discretionary, utility and health-care shares managed to gain ground for the session.  Telecom and basic material shares led the six major industry groups that declined. 

The yield on the two-year Treasury fell to a record 0.367%, which is now below the level at which the Federal Reserve fixed short-term rates during WWII; they pegged long-term yields at 2.5% – yes, interest-rate price controls. 

The Fed accomplished this by buying all the Treasuries necessary to keep rates at those targeted levels. One can absolutely understand this policy so not to be crippled by financing the war, but it did break down the so-called independence the Fed is supposed to have from political meddling.  President Truman and probably the most respected Fed chairman in history, William McChesney Martin, fostered what was termed the 1951 Accord that restored Fed independence. Today we find the central bank has lost its independence yet again as it is closely linked to the Treasury Department due to the current state of things.  More on this below. 

Market Activity for October 7, 2010

Initial Jobless Claims

The Labor Department reported that initial jobless claims fell 11,000 to 445,000 in the week ended October 2 following and upwardly revised 456,000 in the previous week.  Despite the upward revision to the prior reading, this is a nice two-week move from the disturbing level of 470K.  I want to believe we’ll slowly grind down to 400K (we need to get below that level, a mark that suggests meaningful jobs growth is upon us), but we’ve dipped below 450K five times now over the past nine months only to see a summary jump.  We need to see this sub-450K level stick and move lower.

 We’ve been stuck more or less at the 450K range for longer than any time since this data set was introduced in 1967.

The continuing claims data was mixed.  The standard issue (those lasting the traditional 26 weeks) fell 48,000 to 4.462 million – the fourth-straight weekly decline.  However, emergency claims (those that extend out to as long as 99 weeks) jumped 256,500 to 5.123 million.

ICSC Chain Store Sales

The International Council of Shopping Centers reported that year-over-year same-store sales rose 2.6% in September, missing the expected 2.9% increase – August was revised lower to show back-to-school sales rose 3.0% vs. the 3.2% reported last month. 

While the September results missed expectations, frankly it’s not that bad as this is the first month in which the y/o/y comparison wasn’t incredibly easing to beat.  Although, we must keep in mind that government transfer payments as a percentage of total personal income have hit a new high of 18.5% -- the long-term average is 12%.  There is a payback effect to the government’s spending trajectory at some point in the future.

Around the Globe

The ECB (European Union central bank) and the Bank of England held their benchmarks rates at record lows yesterday.  The BoE made no change to its asset purchase program and the ECB, which has wanted to removed some of their support to the banking system and also tighten a bit, found renewed financial-market tensions got in the way of that desire. 

Australia reported 49,500 jobs were created in September (equivalent to a 500K increase in the U.S.) and Canada will probably show their labor market continues to add jobs at a solid pace when their September report is released today.  The commodity-driven economies are certainly outperforming and they can thank the Fed (as its actions have certainly fostered the rebound in commodity prices) and the Chinese government as they haven’t completely taken their foot of the accelerator. 

Musings on the Look of QE2 and What the Fed Should Know

Regarding the above comments on 1940s interest-rate controls, remember all of this as the central bank is likely to bring back interest-rate caps, although they won’t call it that.  There’s word going around that QE2 will involve explicit “targets” on rates across the Treasury curve, but that’s just conjecture at this stage.  What we do have some evidence of is the central strategy of QE2, which will likely involve $100 billion a month in Treasury purchases until the jobless rate falls below 9%.  Should we tell the members of the FOMC that no amount of money will result in durable labor-market improvement?   I think we should because they’re obviously not going to come to the conclusion on their own. 

A little help from the fiscal side – setting an agenda to reform entitlement programs, capping non-discretionary spending to the rate of inflation, elimination of the corporate income tax and a clear message that other tax rates will remain unchanged – would go a long way in helping the Fed right now.  Instead, Washington is only making Bernanke’s job more difficult and greatly increasing the risks of unintended consequences that result from a Fed that continues to take monetary policy further along an untraveled path.   

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Have a great weekend!

Brent Vondera, Senior Analyst