U.S. stocks bounced ahead of the elections and today’s FOMC meeting in which we’ll get the specifics on QE2.  The broad market lost a little steam in the final hour or so, but unlike Monday held nearly all the earlier gains.  The Dow actually hit its highest post-crisis level before pulling back – the S&P 500 is about 2% below its post-crisis high. 

All 10 of the major industry groups gained ground for the session.  Energy, consumer discretionary and utility shares led the way.  Financials and consumer staples were the laggards.

The U.S. dollar took a good beating yesterday as the Australian central bank tightened, while Bernanke embarks on QE2 (more on this below) and that means the CRB advanced – this index that tracks a basket of commodities rose to a new post-crisis high of 305, led by cotton, orange juice and hogs.  All of the grains, metals and soft commodities (food) within the index are either at record highs or very close to those levels.  The Fed is going to crush profit margins.

As we touched on yesterday, the ECB sent an emergency $360 billion Ireland’s way.  Yesterday, Irish government bonds exploded to the widest spread against German bunds (the benchmark for Europe), jumping to an all-time high of 483 basis points on concern the cost of bailing out their banking troubles is rising – it’s funny how people still believe these issues can be bailed out.  Anyway, the U.S. market ignored the news.  It appears the EU sovereign debt crisis will roll again; it was always a matter of time. 

Market Activity for November 2, 2010

Short Rates Above Virtual Zero?  What a Concept

The Reserve Bank of Australia (central bank) decided to raise their benchmark “cash rate” (equivalent of our fed funds) 25 basis points to 4.75% -- recall, the Aussies held off on this increase to 4.75% a few of months back when Chinese factory activity had slowed and that government gave signals they’d tighten policy.  While the Chinese have tightened lending standards just a bit, they’ve kept the government stimulus going and factory activity has rebounded.  Until they take their foot completely off the accelerator (they get that inflation scare) the Aussies will perform.  Further, our own central bank continues to ease monetary policy further, which will hold commodity prices up and that benefits the Aussie economy big time – funny how Fed action helps the rest of the world more than it does our own economic state.

In any event, while the Fed would like all central banks to be working in coordination this just isn’t the case.  As a result, you’ll see the yield seekers continue to rush into the Aussie market, and emerging markets too, for higher investment interest rates.  Alas, such moves will lead to increased volatility (specifically in the currency markets) and very likely another round of economic chaos when the unprecedented levels of accommodations are either removed or pulled in a bit.  That’s looking down the road though. 

U.S. savers can only dream of short rates at 4.75%.  We were there in 2007, for about a year, until the economy collapsed.  This economy has become so conditioned to ultra-low rates, it’s not going to be pretty when they are eventually pushed higher.  But we need to get to it because I’m sorry to say, ultra-low rates and manipulating markets isn’t the answer; it only delays the inevitable and foments additional problems to come. 

Huge Week

Beyond the political realm, which obviously makes this week even more significant, we’ll get several major economic releases/announcements. 

(And quickly on the election, republicans needed 39 to take the House and 10 for Senate majority.  They got 60 seats, maybe 64 when it’s all in, in the House and the agenda is going to change dramatically within that arm of Congress; Senate results weren’t so amazing though with something like a pickup of four seats; the Senate will still block much of what comes out of the House.  This means we’ve got textbook gridlock, which is normally a good thing for the markets but this is far from a normal environment and what we need is a complete shift in policy – a shift that seems highly unlikely to me with a divided Congress because it would take the President to completely change course.  Stranger things have happened, but the odds are not in favor of such a change.)

Back to the economic releases, we start it off this morning with the ADP Employment survey and the Institute for Supply Management’s gauge of service-sector activity for October. This of course is followed by the FOMC announcement when the statement explains how the Fed will manage QE2 in at least its first few months of implementation. 

On the ISM’s service-sector gauge, the market is looking for the reading to remain largely unchanged at the 53 handle – if either ISM’s factory or service gauge dips below the 50 mark (indicating contraction), there’s a real possibility the market will look beyond what the Fed is doing and commiserate over just how weak this recovery is, and possibly it’s very short life cycle. 

On the FOMC, they’ll state something like $100 billion in Treasury security purchases over the next few months (completely financing the debt over the next several months), leaving open the ultimate size of this round of QE, saying it will be data dependent.  They may also shift their comfort-zone target for inflation upward, but I think they’ll wait for additional deterioration before doing so.  

Later in the week we round it out with the October jobs report.  The expectation is for an increase of 60,000 payrolls (79,000 from the private sector).  The official jobless rate is expected to remain unchanged at 9.6%.  Eventually though, a large pool of discouraged workers (those who have not been looking for a job and thus are no longer included in the official unemployment figures) will begin to re-enter the workforce and we’ll need at least 150K-175K in monthly payroll increases to absorb that supply or the jobless rate will rise again. 

(That said, I think there is a chance the jobless rate will fall back to 9% before returning to 10% -- assuming we don’t get surging job growth. It’s even tougher than normal to gauge these days due to the changes in unemployment benefits, but the emergency level of benefits -- allowing the unemployed to collect for up to 99 weeks -- will expire in November and that means we may see a segment of the 99ers drop out of the workforce – they’ve had to say they’re looking for work to get to the benefit – and that means an artificial drop in the jobless rate.  But it will prove temporary absent the 3.5% GDP growth needed to fire up the labor market.)

In addition to the official jobless reading, we’ll watch the underemployment and long-term unemployment figures.  The underemployment rate increased last month from 16.7% to 17.1%.  The long-term unemployment figures improved last month but remain at levels never before seen in the postwar era.

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Have a great day!

Brent Vondera, Senior Analyst