The action today highlights the great difficulties the Fed is facing. Retail sales are stronger than expected, but the response is modest because there is an underlying sentiment of anxiety about the consumer regardless of the current data. Sell into any retail rally is the mantra of the bears.
The problem. The dilemma facing the Fed is simple: the growth risk is to the downside, but the inflation risk is to the upside. The inflation risk is rearing its head in a big way today, as gold futures move over $700 (52-week high), wheat remains near multi-decade highs, and oil remains over $75.
Commodities soaring. Bulls have been arguing for weeks that gold should move up on the expectation that Fed cuts will weaken the dollar and thus benefit gold (gold is dollar-denominated, so it is cheaper to buy in foreign currencies when the dollar is weak). That may be true, but gold really only shot up when the futures contract passed $700 today--a technical move.
What do traders want? As for the economic data, it boils down to a simple question: what do you want? Do you want: 1) weak economic data and a Fed rate cut, or 2) strong economic data and no rate cut. Most traders I talked to will take strong, non inflationary data over a rate cut; however most agree that to the extent the market is pricing in a rate cut, and it doesn't get it, traders will be disappointed and stocks may drop, at least short term.
The jobs report. This leaves tomorrow jobs data as the key economic report before the Fed meeting September 18th. There have been some signs of weakness in the employment trends recently. Very strong data will clearly reduce the chances of a cut; very weak data will revive the belief a cut is imminent. The worst case scenario for the stock market is a jobs report that is in line or just slightly below expectations; this will leave traders confused about the Fed's intentions and put more weight on the weekly jobless claim numbers.
Will a rate cut help? Finally, many are arguing against a rate cut because it is not clear it will greatly aid the liquidity crisis. Bulls concede there is uncertainty here, but argue that a rate cut WILL undoubtedly help an economic slowdown. And let's be cynical and face facts: throwing money at a problem usually does produce a response. It may not be the right way to proceed philosophically, but it does produce a response.
And finally, if things aren't confusing enough, a lot of traders believe the Fed--in the absence of a clear sign to cut--will elect to do nothing IF nothing happens--in other words, if there is no further dramatic meltdown and the data continues to come in at least mixed on the growth issue.
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