Updated from 3:31 p.m. EDT
In a welcome relief from the angst-ridden rate decisions earlier this year, it was status quo for the markets Wednesday as the
kept rates unchanged, as was widely expected.
For the second meeting in a row, Fed policymakers left their target fed funds rate steady, and blamed the cooling housing market for moderating U.S. economic growth. The target rate remains at 5.25%. Prior to the August meeting, the FOMC had raised rates by 25 basis points at 17 consecutive policy meetings.
The major averages marched on toward new highs despite a nonchalant reaction to the FOMC decision. The
closed just below a five-year high, up 0.52% at 1325.18. The S&P 500 is 13.25% off its all-time highs. The
Dow Jones Industrial Average
finished up 0.63% at 11,613.19, just 0.25% away from its May high and 0.93% away from its all-time high of 11,722.98 reached on Jan. 14, 2000. The
gained 1.4% to 2252.89, still 3.92% off its May highs and more than 50% away from its all-time high.
The Fed's statement accompanying the decision attributed the slowing economy in part to a cooling housing market, but it left out high energy prices and the lag effects of prior rate hikes. Indeed, energy prices have been moderating, which the Fed acknowledged even though it retained its tightening bias. "Some inflation risks remain," read the statement, adding the now-familiar data-dependent caveat.
"Readings on core inflation have been elevated, and the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures," the Fed said.
"However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand," the statement continued.
"There is a simple message from the Fed right now, which is 'we're uncertain about where things are headed here and we want to buy some time ... we may need to hike rates further but let's see what is happening here in the housing market,' " says Ethan Harris, chief economist at Lehman Brothers. The focus on housing is apt, says Harris, suggesting the economy looks healthy outside of housing.
Despite the Fed's continued tightening bias, the bond market continues to overdiscount the inflation story, says Harris. The yield curve remains wholly inverted relative to the 5.25% fed funds rate.
"At the margin, the statement was a bit more dovish," says T.J. Marta, senior fixed-income strategist at RBC Capital Markets, on the Fed's acknowledgement that inflation pressure is not coming from energy prices. Energy prices have fallen sharply since the last FOMC meeting. Oil in particular has fallen about 20%, and crude hit a six-month low of $60.46 Wednesday.
That said, the bond market barely reacted to the Fed news. The 10-year Treasury closed up 2/32 to yield 4.73%.
Richmond Fed President Jeffrey Lacker dissented for the second time regarding the Fed's decision. The committee-member's argument is compelling, says Marta. If the Fed's central tendency for core personal consumption expenditures (the Fed's favored measure of inflation) is above 2% through 2008, as its forecast suggests, that adds up to about four years of inflation above the Fed's supposed 1% to 2% comfort zone, says Marta. "Is that a credibility issue?"
Lacker is concerned about this, but as long as inflation expectations are contained, Marta expects the Fed will allow this slightly higher rate of inflation to persist.
The stock market rallied throughout the day Wednesday as strong earnings reports and falling oil prices sparked traders' optimism. In the constant flip-flop between rose-colored and dark-tinted lenses, traders fell on the positive side of the fence regarding a soft landing Wednesday.
"We're all holding our breath on housing," says Frank Husic, managing partner at Husic Capital Management. Husic is bullish on stocks at the moment, adding that "things seem to me to be setting up well," with energy prices down, the housing market cooling but not collapsing, and corporate profits "through the roof."
Strength in the financials sector and the divergence in the homebuilders' stock prices despite the fundamental bad news in that space are also encouraging, he says.
Wednesday's earnings fell in step with Husic's point of view as strong earnings reports call into question the idea the economy is sliding toward recession.
and electronics retailer
all reported earnings that beat analyst expectations.
Oracle shares gained 11.16% as other tech bellwethers went up in concert.
ended up 1.19% and
gained 1.89% Wednesday.
Morgan Stanley's report followed strong postings last week by competitors
( BSC) and
( LEH). Shares of Morgan Stanley ended the day up 0.70% Wednesday. The Amex Securities Broker Dealer Index gained 2.02%.
Circuit City followed up
strong earnings report last week, and cast doubt on the notion that the consumer has closed the collective pocketbook. The retailers both reported healthy back-to-school sales and an uptick in flat-panel televisions sales. Circuit City's shares were up as much as 3.5% Wednesday intraday, but ended down 0.11%, and Best Buy's ended up 2.29%.
Status quo for the markets is quite a departure from the previous Fed rallies and post-Fed troughs. With the markets and the Fed comfortable with the pause in interest rates, the focus turns to profits as the third quarter comes to an end. If the market keeps seeing strong earnings, September could defy the seasonal odds and remain rosy.
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
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