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Fed Minutes a Minor Obstacle

The Dow is tripped up by GM but the May 3 FOMC minutes prove mainly to be a nonevent.
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Blue chips succumbed to a bout of profit-taking on Tuesday, but other major indices ticked higher as investors gave a muted cheer to the


fairly benign three-week-old views on the economy and inflation.

After much anticipation, the minutes of the Federal Open Market Committee's May 3 meeting mainly served to confirm the view that the Fed had already dismissed weak economic data in March as evidence of a "transitory" soft patch.

Amid concerns about price pressures, more members favored removing the "measured pace" language used to describe the quarter-point hikes issued by the Fed over the past year. But as the market already knew, most Fed members agreed to continue nudging rates higher at the current pace; since then, investors have received indications of tame inflation.

After trading as low as 10,472, the

Dow Jones Industrial Average

closed down 19.88 points, or 0.2%, to 10,503.68, weighed down by Fitch's downgrade of

General Motors


debt to junk status. With two out of three rating agencies having taken the step, GM bonds will not be allowed in many pension funds and will likely be removed from the Lehman Brothers Investment Grade Bond index, the benchmark for most corporate bond funds. The Dow component sank 2.8%.


S&P 500

rose 0.21 points, or 0.02%, to 1194.07. The

Nasdaq Composite

rose 4.97 points, or 0.2%, to 2061.62 after trading as low as 2049 intraday.

The gains aside, breadth was negative, with decliners beating advancers by 17 to 16 on the


and 8 to 7 on the Nasdaq. Volume remained light with 1.3 billion shares trading on the Big Board, and 1.7 billion changing hands on the Nasdaq.

Resolve to Tighten

The market's impressive rally over the past few weeks followed a strong April employment report and retail sales, which eased fears over slowing growth. Investor relief was further validated after evidence of tame inflation in last week's April consumer price index. Not surprisingly in this context, the market didn't see any new meaningful signs from the dated FOMC minutes.

In addition, the Fed's next rate-setting meeting is scheduled for the end of the June, which will give the Fed a lot more time -- and more economic data -- to make up its mind on the future direction of rates, investors reasoned.

But in the interim, the market might not be fully accounting for the Fed's determination to continue tightening: One thing noticeably absent from the FOMC minutes was evidence of the Fed's softening resolve.

On average, the market expects another three quarter-point rate hikes before year-end, according to Morgan Stanley economist Richard Berner. But there are rising expectations that the Fed could stop there. Some even expect the Fed may stop altogether after one or two more rate hikes.

Berner disagrees. "The projected resumption of hearty growth and rising inflation that I see mean that it's worthwhile betting against the benign consensus," he says.

The latest Fed minutes noted that there was no evidence of the slowing impact of the already 200 basis-point increase in the fed funds rates since last year.

And the employment picture was also notably absent from the Fed's May 3 statement and from the just-released minutes. Employment costs account for roughly 70% of inflationary pressures. The meeting preceded the strong April employment report released on May 6.

Some economists are still debating what the historically pretty tame job growth of the current economic cycles means for inflation. According to Berner, the Fed is also expecting these costs to start accelerating. "I'm confident that compensation will begin gradually to accelerate, reflecting tighter labor markets and rising inflation expectations," he says.

It is also notable that the Fed's minutes mentioned concerns about speculation in real estate, a theme that Fed Chairman Alan Greenspan also addressed on Friday. "The Fed approaches this as an indirect indicator of future inflation, one that could lead to overheating consumption, but is not a sign of core inflation trends," says Lehman Brothers senior economist Ethan Harris.

"But they probably are concerned that they're not getting much restraint on

the housing front," the economist continued. Stubbornly low long-term Treasury yields are keeping mortgage rates low and further fueling the red-hot housing market. "That's therefore another hawkish signal for the Fed," Harris says. He predicts the Fed will nudge its key rate to 3.75% by year-end and by 4.25% next year.

On Tuesday, the benchmark 10-year Treasury gained another 6/32 while its yield, which moves inversely to price, fell to 4.03%.

A Little Froth

"There are a number of things, which I think suggest at a minimum, there is a little froth is this market," Greenspan said of real estate after a speech he delivered in New York on Friday.

As if on cue Tuesday, the National of Realtors reported that existing-home sales rose to a record 7.18 million units in April, up from 6.87 million in March, and above consensus forecasts for sales to rise to 6.90 million.

And the median price for these homes is up 15.1% from last year, marking the largest price appreciation in nearly 25 years.

"These data do help support our view that there is no chance of a spontaneous slowing in home sales," says Ian Shepherdson, chief U.S. economist at High Frequency Economics. "The market will soften if -- and only if -- mortgage rates rise significantly."

Far from rising significantly, mortgage rates have even fallen over the past couple of months, and remain near historic lows.

That may be good news if one plans to ride the wave a bit longer on the homebuilders, such as

Toll Brothers





, each of which gained more than 1% Tuesday.

Among other stocks on the move,



rose 2.5% after a clinical trial of an experimental eye-disease drug showed promising results. But over concerns Genentech's Lucentis will erode the sales of their eye-disease drugs, Genentech's gain came at the expense of competitors such as



, which tumbled 46%, and



, down 13.4%.



shares rose 18% after First Albany Capital initiated coverage of the digital video recorder giant with a strong buy rating.

In other analyst action,

Marvell Technology


rose 4.2% after Jefferies initiated coverage with a buy rating and



gained 1.7% following upbeat comments out of J.P. Morgan.

To view Aaron Task's video take on today's market, click here


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

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