11 May 2007 Will The Fed Blink Soon?

The bulls of the Dow Jones Industrial Index took a deep breath yesterday with a 147 point gasp. But it was a rare one. Over the last 28 trading days, including all of April and May so far, the index declined only four days. If today’s trend continues, the Dow will close up enough for a flat finish for the week saving the five-week streak. Mega corporate buyouts, potential for a Fed rate cut, reasonable stock valuations and old fashioned-momentum are propelling the averages.

Yesterday’s tumble came when retailers reported the biggest sales decline on record. As the consumer is the mainstay of this economic expansion, even a hiccup in sentiment or spending can send shockwaves. Higher gasoline prices, declining home prices, and rising unemployment may finally be getting the consumer’s attention. A gallon of gasoline averaged $2.57 in March and $2.83 in April. According to the American Automobile Association, the average price reached $3.04 yesterday; an 18% increase in just two months and just shy of the %3.06 record set after Hurricane Katrina. 

The labor market, which in the past few months has helped relieve the ill effects of declining housing prices and rising fuel costs, is showing fatigue. Businesses created only 88,000 jobs last month, the fewest in more than two years. The widely published unemployment rate rose to 4.5% from a five-year low. 

Corporate earnings for S&P 500 companies grew an average 12.1% in the first quarter with 88% of the index’s members reporting. But analysts expect earnings to slow to 3.8% this quarter. We think they will revise that number higher as the strong global economy will likely buoy US earnings. 

Economic data reinforce the notion of a slowing economy, but there remains scant reason for concern at this point. The Fed said as much on Tuesday. While their comments did not provide any indication of their upcoming rate decisions, the market seems to expect a rate cut sooner rather than later. The April producer price report suggested continued slowing of inflation, giving them added leeway to cut rates should they deem it necessary to boost the economy’s growth.

Yesterday’s report of the dramatic drop in consumer spending was a shot across the Fed’s bow. While the market seems to believe otherwise, close observers of Fed talk and body language find it hard to believe they will change their course on rates until shots begin bringing down the rigging. We hope the market is right and not the Fed watchers.

Hold fast me-hearties.