Bernanke Burns the Bulls

The Fed chief's reported about-face sends stocks and bonds falling.
Publish date:

As the rest of the world reveled Monday in the rites of spring, the U.S. markets herked and jerked, weighing the


commitment to vigilance on the back of more strong economic data -- and some backtracking by Ben Bernanke.

The dollar and U.S. Treasury bonds sold off through most of the day, while U.S. stocks and commodities began a spin up the maypole. But stocks turned violently lower on the words of


Maria Bartiromo, who said Bernanke, the Fed chairman, mentioned to her this weekend that he's unhappy with his growing reputation as a "dove."



personality reported that the Fed chief said markets were "wrong" to react to his congressional testimony last Thursday as necessarily telegraphing a pause in June. She reported that Bernanke said it is "worrisome" that people don't see him as an "aggressive inflation fighter," and claimed that his comments had been designed to create flexibility -- not cement faith in the one-and-done scenario.

"I think the market is getting used to Mr. Bernanke in his new role," said Jack Malvey, chief global fixed-income strategist at Lehman Brothers.

The remarks, supported by subsequent comments by Chicago Fed President Michael Moskow, called back into question whether or not the Fed will take a breather after raising the fed funds rate in May 10, or hike again to 5.25%.

Indeed, the odds that the Fed will hike again in June jumped to about 42%, from 24% Friday, after the Bernanke headlines, according to Miller Tabak. The

Dow Jones Industrial Average

closed down 24 points, or 0.2%, at 11,343, while the

S&P 500

fell 5 points, to 1305, and the

Nasdaq Composite

, which had struggled throughout the day dropped 18 points to 2304.

Bernanke might have had good reason to jump back into the fray. Signs that risk appetite is abating or that the economy is slowing are almost nonexistent, so the Fed's insistence that its policy is working or that inflation is "contained" is sounding stale. Most indicators are surpassing expectations, and predictions that the germs of a housing market slowdown would curb the U.S. consumer have been dashed at almost every juncture.

Monday, the Commerce Department reported that personal income grew 0.8% and spending 0.6%, beating expectations for 0.4% growth on both measures. Core prices, which exclude food and energy, climbed 0.3%, the biggest gain since October. In addition,


(WMT) - Get Report

reported April sales figures that beat expectations. While many attribute the increase to a late Easter, sales are sales. The company's stock was up 2.8% to close at $46.29.

Another gainer amid the drama were shares of


(BA) - Get Report

, which said it plans to buy parts maker



for $1.7 billion. Its stock was up 0.5%. In other M&A news,

Level 3's


plans to buy TelCove for $1.2 billion sent Level 3's stock up 7.1% to close at $5.78.

As evidenced by all the M&A, corporate spending is hardly a soft spot. Durable goods orders surpassed expectations last week, and the Institute for Supply Management reported that its factory index rose to 57.3 in March, beating expectations of 55.1.

With corporate profits expected to grow about 16% in the first quarter, corporate credit spreads tightened against a declining U.S. Treasuries market over the past couple of weeks. Why shouldn't they? Companies have a record $1.42 trillion of cash on their balance sheets through the end of December, according to Moody's Investors Service. Corporate credit volatility has been extremely low too, said Ed Marrinan, chief credit strategist at JPMorgan.

In other signs of voracious risk appetite, the private equity industry has so much cash it doesn't know what to do with it. Food services company



is the latest LBO target, for about $6 billion, according to news reports Monday. Kohlberg Kravis Roberts' is launching a retail buyout fund via the Amsterdam Euronext exchange, and it is has garnered over $2 billion worth of interest, according to several reports. The average price of a triple-C-rated junk bond is currently 92 cents on the dollar, according to Merrill Lynch -- a level not seen since 1997, when high-yield credit spreads reached all-time lows.

With risk tolerances this high, maybe this is a good moment to investigate what could give the markets problems. Doomsday scenarios aside, there are a few threats.

It could be the "ungluing of the carry trade," as Leverage World CEO and publisher Marty Fridson notes. Investors looking for an example of such a scenario might consider Iceland, where capital was pulled out of krona-denominated assets in droves after the country's credit quality came into question earlier this year. The country has a current account deficit amounting to roughly 16.5% of its GDP.

If Japan raises its interest rates, the carry trade could take more hits, said Fridson.

The dollar's current selloff certainly doesn't make U.S. securities more attractive for foreign investors. The dollar slid to a six-month low Monday against the yen, to 113.35, as fears mounted that the Bank of Japan will raise rates for the first time since 2000. The 10-year Treasury fell 17/32 to yield 5.13% Monday.

"Threats to our marketplace may come from shareholder activists or a Fed that comes back to hike rates aggressively," says JPMorgan's Marrinan. He added that anecdotal evidence suggests corporate credit investors are most concerned about geopolitical problems roiling the current market momentum.

Meanwhile, light, sweet crude oil rose $1.82 at $73.70 per barrel amid the conflict over Iran's uranium enrichment program.

But like functioning alcoholics, perhaps U.S. markets can stay on their feet -- even with these risks in place. The proliferation of credit derivatives and hedge funds has given risk a happy home, for example.

"There are plenty of things to be nervous about, and it is counterintuitive to people that we're not sitting on the edge of a volcano," said Fridson. "But we may be having the same conversation a year from now."

Against such a backdrop, the Fed's slow and steady monetary tightening may require an unexpected shock to augment the lagging effects of its 15 hikes thus far.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


to send her an email.