Fed Handicappers Stymied by Today's Data, Greenspeak

There's a clamor on the Street for a 50 basis-point Fed cut but some are suggesting not so fast, maybe 25 is more reasonable.
By Robert Mann ,

SAN FRANCISCO -- Last week, we reported on the

rising anticipation for a 50 basis-point ease from the

Fed

, and how it might provide a catalyst to equities. Stocks haven't exactly exploded higher this week, and major averages again failed to sustain early gains today.

Still, the

Dow Jones Industrial Average

closed up 0.5% while the

S&P 500

gained 0.9% and the

Nasdaq Composite

rose 1.9%.

The potential for another half-point cut perhaps explains why stocks haven't fared

worse

in the face of declining fundamentals. Not even warnings from

Tellabs

(TLAB)

and

Jabil Circuit

(JBL) - Get Report

, and the apparent death of the

General Electric

(GE) - Get Report

-

Honeywell

(HON) - Get Report

deal could shake the mildly positive tone in the session.

Certainly other positive forces have aided stocks -- including strong earnings from

Bear Stearns

(BSC)

and

Lennar

(LEN) - Get Report

today. But the case for another aggressive ease has

gained steam this week. Eight primary bond dealers now forecast a 50 basis-point cut on June 26-27 vs. six on June 15,

Reuters

reported.

As of yesterday, fed funds futures were pricing in a 50% chance of a 50 basis-point cut, up from less than 25% at the beginning of last week. However, the trend of rising odds of a 50 basis-point ease paused today, with the odds slipping back to 48%.

In testimony before the

Senate Banking Committee

, Fed Chairman

Alan Greenspan

said that while unit labor costs have risen, "we've seen no evidence that those costs are being passed through into final prices in any material way." He said the same regarding the "fairly extraordinary increases" in energy prices, which have recently subsided.

Some observers presumed those comments mean the Fed chieftain remains sanguine about inflation, and that a 50 basis-point cut is in the works.

But the Fed head also said "we have to be very careful about any evidences of emerging inflationary instability, because history has told us time and time again that the most effective productive economies are those with stable prices."

That comment, in conjunction with a stronger-than-expected report on the

Index of Leading Economic Indicators

(LEI), suggested to others that 25 basis points is more likely. The

Conference Board's

index rose 0.5% in May, more than double the expected rise and its biggest gain since December 1999. Furthermore, the index has now risen two consecutive months for the first time since November-December 1999.

In conjunction with the fed funds futures, the two-year Treasury note reflected the market's ambivalence about the meaning of today's data and Greenspeak, finishing unchanged at 100 17/32 to yield 3.96%.

LEI is a "grade B" piece of data "but it's got to count for something," said Anthony Crescenzi, chief bond strategist at

Miller Tabak

. Similarly, "Greenspan's comments leaned toward a quarter-point move. He sound optimistic about inflation, but gave a good hedge to show they do harbor some concern about the

recent uptick."

Crescenzi suggested Greenspan's comments might have been an attempt to mollify the more hawkish members of the central bank. In recent weeks, Fed Governor Laurence H. Meyer,

Richmond Fed

President Alfred Broaddus and

Boston Fed

President Cathy Minehan have made comments suggesting the economy is poised to rebound and/or that inflation could re-emerge.

The chairman's comments about rising unit labor costs jibe with those of Meyer, who has warned that if labor costs are rising in a slumping economy, they might soar if and when the economy rebounds. "That was one of the most important things

Greenspan said today," Crescenzi commented. "Between labor costs and the inflation comments,

Fed officials do have an eye on the other side of the economic slowdown."

Along with recent signs of economic malaise and declining energy prices, that suggests the yield curve will start flattening, he said. In other words, higher yields in the short end of the curve and lower yields at the long end.

The long end of the bond market rose today, indicating bond traders agree that Greenspan's comments meant the Fed will remain vigilant against inflation. The price of the benchmark 10-year rose 6/32 to 98 13/32, its yield falling to 5.21%. The 30-year bond rose 10/32 to 95 27/32, its yield falling to 5.66%.

One reason the Fed may lower rates by 25 basis points next week is to "get more bang at the long end of the market," which has reacted negatively to recent aggressive cuts, said David Orr, chief capital markets economist at

First Union

in Charlotte, N.C. A 25 basis-point cut "helps the whole yield curve and keeps mortgage rates down."

Orr gives a slight edge to odds for a quarter-point ease, but believes the accompanying statement will contain language indicating the Fed will move intermeeting if necessary.

Regardless, he expects fed funds to be at 3.50% by the Fed's Aug. 21 meeting and is "agnostic" on whether it gets there via two 25 basis-point cuts or one 50 point cut.

Perhaps equity investors still hanging on every Fed action should take a similar view, although it's very likely expectations about the Fed's meeting next week will hold some sway over the short-term action.

Wrong Way, Roy

Speaking of expectations, Thomas McManus, equity portfolio strategist at

Banc of America Securities

, today cut his S&P 500 earning expectations for 2001 to $50.50 from $52 and to $56.50 from $59 for 2002.

The strategist predicted a 16% decline from year-ago levels for second-quarter earnings, roughly in line with the

I/B/E/S

consensus estimate. But he expects a 10% decline in the third quarter vs. consensus expectations for a 5.1% drop and forecast a 1.5% rise in the fourth quarter vs. consensus for a 7.9% gain.

Perhaps for that disparity, McManus remains cautious on equities, despite forecasting the current quarter will be the trough for earnings growth.

"Given the treacherous earnings environment and generous valuations, we still suggest equity allocations should be somewhat lower than normal, with a corresponding overweighting for bonds," he wrote.

McManus, who could not be reached for additional comment, maintains a recommended weighting of 60% stocks, 35% bonds and 5% cash, which he first adopted on

April 23.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.

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