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Fed to Maintain Dovish Stance as Earnings Ruffle Markets

Fed officials, huddling in Washington for a second day Wednesday, are likely to be discussing how to tweak policy later in the year.

Those changes could include a new way of communicating their low rate policy, and what they will do when their Operation Twist ends in December.

"It's more likely they talk about it at this meeting and then use the minutes to give the market a heads up and then make changes in December," said Ward McCarthy, chief financial economist at Jefferies. The minutes from the meeting are released in mid-November.

The Fed winds down its meeting with a statement at 2:15 p.m. Wednesday. There is no press conference or economic projections, following this meeting.

"I think they're going to be sitting around talking about communications for the next two days. There's some possibility that they change the way they talk about the rate guidance in that they put it in the context of their economic forecast or metrics that would be consistent with their dual mandate," McCarthy said. He expects the Fed to continue purchasing longer-dated Treasurys after its Twist program expires. Currently, the Fed sells the same amount of shorter-dated notes so as not to expand its balance sheet.

He and others expect the Fed will add Treasury purchases to its open-ended quantitative easing program, QE3. Under QE3, the Fed is buying $40 billion in mortgage securities a month.

"They've been very successful keeping rates low and stable, and keeping spreads narrow. To a certain degree, I think they contribute to the rising stock market. Corporations that have been flush with cash have been able to borrow at these low rates, and buy their stock back," said McCarthy. "The financial consequences are clear. What's less clear is to what extent this is supporting the economy. While Fed policy is providing stimulus, fiscal policy is going the other way."

Fiscal policy, or the fear of it, has been weighing on the stock market. Some analysts say the fear of the "fiscal cliff," the expiration of Bush-era tax cuts at year end and the onset of automatic spending cuts, has created enough uncertainty to have weighed on corporate profits this quarter, along with the effect of a sluggish global economy.

More bad earnings news Tuesday sent stocks careening. The Dow ended down 243 points at 13,102, its third biggest drop this year. Blue chips 3M and Dupont both lowered their guidance, with Dupont saying demand would be "substantially" lower for titanium dioxide, a paint pigment that is seen as a key indicator of global demand. The S&P 500 was down 1.4 percent at 1413, and the Nasdaq was down 26 points at 2990.

Corporate chieftains have been laying blame for sluggish profit growth, a stalled business environment and overall malaise increasingly on the uncertainty coming from Washington on taxes and fiscal policy ahead of the election. Of course, the global economy gets its share of the blame, but the "cliff" is increasingly being cited. The economy would hit the "cliff," unless Congress acts to extend some tax cuts and redirect spending cuts in its lame duck session.

"The whole move is about earnings in the industrial and tech sectors and that is all about weak capital spending, and that is a function of public policy uncertainty," said Barry Knapp, head of equity portfolio strategy at Barclays.

As of Tuesday, 57 percent of the 145 S&P 500 companies that have reported beat earnings estimates, according to Thomson Reuters. That is slightly below recent averages, but the worse news is that 63 percent of the companies are missing revenue forecasts.

"It's revenues season and guidance season that stink. The upside earnings surprises are just about close to average but the revenue side is a disaster," said Art Hogan of Lazard Capital Parnters. "It begs the question – in some of these household names, what were they thinking with not pre-announcing?" He said if they had, the market may have felt bumps earlier but the damage to individual stocks would have been less severe.

Analysts have been waiting for a shakeout in stocks, which had run close to their year highs just last week, and the earnings season may be that catalyst. But most strategists expect any sell off to be fairly shallow because the Fed's programs are keeping a floor under stocks.

Technology stocks have been perhaps the most painful misses, with some big surprises in big names, like Microsoft and Google and IBM . On Monday, Western Digital reported positive surprises in earnings and revenue, but its stock later sold off on a forecast shortfall. The company said economic uncertainty is taking a toll on IT spending, and CEO John Coyne was quoted by Reuters as saying: "We have got elections, we have got changes in government, we have got fiscal cliff…lots of different things that undoubtedly are impacting spending at a corporate and a consumer level."

Surprise!

At least one company surprised positively Tuesday, and that was Facebook, a company analysts thought would misfire. The company's stock soared more than 13 percent after the closing bell. It reported earnings of 12 cents per share on revenues of $1.26 billion. It also showed that ad revenues are accelerating and that mobile is becoming more important.

What to Watch

Economic reports Wednesday include Markit PMI reports from Europe as well as the 9 a.m. Flash Markit PMI for the U.S. New home sales and FHFA home price data are released at 10 a.m. There is a $35 billion auction of 5-year notes at 1 p.m.

Earnings releases are expected from AT&T, Bristol-Myers Squibb, Boeing, SAP, American Electric Power, Delta Airlines, Corning, Dr. Pepper Snapple, Lockheed Martin, Nasdaq OMX, Owens Corning, T.Rowe Price, Tupperware, US Airways, WR Grace and Six Flags Entertainment. Companies reporting after the market close include Zynga, Akamai, Citrix, Ameriprise Financial, F5 Networks, Angie's List, Logitech, Symantec, KBR, AvalonBay.

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BMY
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SAP
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AEP
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DAL
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NDAQ
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OC
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TROW
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GRA
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SIX
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ZYGNA
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AKAM
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CTXS
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AMP
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FFIV
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ANGI
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LOG.N
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SYMC
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KBR
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AVB
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Follow Patti Domm on Twitter: @pattidomm

Questions? Comments? Email us at marketinsider@cnbc.com

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • CNBC Personal Finance Correspondent

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.