Week Ahead: Fed Expected to Launch New Program While Europe Debt Troubles Bubble

The Fed in the week ahead is widely expected to pull the trigger on a new easing program, as the European debt crisis continues to boil.

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The housing market will also be a focus when new and existing home sales data is released Tuesday and Wednesday. New data this past week showed a jump in foreclosure starts, signaling that a big wave of foreclosed properties will hit the struggling housing market early next year.

The Dow and S&P 500 had their best week since Julyand second best week since July 2010, as European officials showed support for Greece. The Nasdaq did even better — jumping 6.3 percent, for its best week since July, 2009.

Market expectations are high that the Fed will announce a new program — dubbed "operation twist" — at the end of its two-day meeting Wednesday.

"Twist" is different than the much larger scale "QE2" quantitative easing program which involved the purchase of $600 billion in Treasury securities. Fed watchers expect this program to raise the duration of the securities the Fed holds, not the amount. The program, in theory, could reduce long-term interest rates as the Fed buys more securities in the middle and longer end of the yield curve.

"It's not their job to bail out the whole world, but next week there's high expectations for the Fed," said Nomura Americas Treasury strategist George Goncalves. The Fed this past week joined with the European Central Bank and others to provide more dollar liquidity for euro zone financial institutions.

European finance ministers ended their meeting in Poland with no signs of progress in handling the sovereign debt crisis. Some traders were looking for the officials to provide some clarity on the purchases of sovereign debt, which so far has fallen to the ECB. The euro zone countries are in the process of voting on enhancing the powers of the European Financial Stabilization Facility bailout fund, or EFSF.

In the coming week, the IMF meets in Washington and Europe will certainly be on the agenda. Ahead of that meeting, representatives of the BRICS (Brazil, Russia, India, China, and South Africa) are expected to meet to discuss whether they can help the European situation.

Meanwhile, Greek Prime Minister George Papandreou canceled his trip to the U.S.He said in a statement that the coming week is "particularly critical for the implementation of the July 21 decisions in the euro area and the initiatives which the country must undertake."

Inspectors from the IMF, EU and ECB will be working with Greek officials this week as they struggle to get approval for their next 8 billion euro funding tranche, without which Greece would default.

President Obama is expected on Monday to propose a new tax rate for people making over $1 million, dubbed the "Buffett Tax,"after billionaire investor Warren Buffett famously complained he wasn't paying enough taxes. It will replace the alternative minimum tax and was designed to ensure that the wealthy will pay at least the same rate as the middle class. The president is also expected to put forth a proposal seeking $300 billion to $500 billion in Medicare and Medicaid savings over the next 10 years.

Fed Twists Again

But the Fed remains a top focus for markets. Pimco's Tony Crescenzi said the wobbling economy is a factor that will help push the Fed into "operation twist," named for a Fed program from the early 1960s.

"The Fed will likely attempt to spur another leap of faith, pushing investors to move out the risk spectrum and away form riskless assets, and deposits, to support asset prices, boost wealth and aid the deleveraging process," said Crescenzi, senior strategist at Pimco.

Crescenzi said the Fed could direct its current Treasury purchases toward the long end of the curve. It currently invests roughly $20 billion per month in Treasurys, using the runoff from its mortgage portfolio. Or, it could decide to sell some of its shorter duration holdings and repurchase longer duration securities.

"Bernanke has done nothing to dissuade markets of the notion that there will be some form of 'operation twist.' He had opportunities. Therefore, the market believes there will be a form of 'operation twist' next week," said Crescenzi.

In the bond market, as traders debate exactly what the Fed will do, they will also debate the Fed's focus. Some believe the Fed is likely to buy the middle of the curve — 5- and 7-year notes — as well as the 10-year but avoid the longest duration, 30-year bond, which would be more difficult to unwind.

"They're going to overweight the 7- to 15-year part of the curve. They're going to focus their money there," said Goncalves. He said the Fed will also continue to buy some 30-years, as it currently does when it reinvests its mortgage proceeds. Goncalves expects the Fed to do the "light" version of "operation twist," where it would just use the existing $20 billion a month and not sell its short duration holdings.

Richard Bernstein, CEO of Richard Bernstein Capital Management, said he does not expect the Fed to embark on any programs beyond the "twist." Some analysts had been looking for the Fed to discuss a third quantitative easing program in the next few months.

"I think the politics are such that the Fed basically is hog tied. 'Operation twist' is not new stimulus. It's carrying on. What the Fed is trying to do is flatten the curve so they bring longer term rates down...you can't solve a monetary bubble with monetary policy so I t think it's a little disheartening," Bernstein said.

Whither Stocks?

The Dow in the past week rose 4.7 percent to 11,509, and the S&P 500 was up 5.4 percent to 1216. Nasdaq rose 154 points to 2622.

Bernstein said he remains cautious on equities. He said investors are too focused on the negative tone of politics, and "the pointing fingers" in Washington. "It's detrimental to people's portfolios to listen to these guys," he said

Even so, he is still looking for a catalyst to take the market higher, and for now he does not expect the market make much progress by year end. "Point-to-point, I don't think people should expect the market to do a lot, but we'll have technical rallies both up and down through the end of the year," he said.

Even so, stocks are getting to attractive levels. "Valuations are fantastic but that doesn't mean anything. You don't buy on value. You have to wait for a catalyst. Even sentiment is great. Just look at the price of gold. People think gold is the only thing you can invest in," Bernstein said. However, the fundamental indicators that he watches are mixed, including jobless claims which once more increased this past week.

"Every early cycle is dominated by the government. Then what happens is the government hands off the ball to the private sector, but this time they fumbled it. I think what's happened is they didn't do anything to promote investment spending in the United States," he said.

"We are looking for the catalyst that will get us out of the funk. The most likely thing that could happen, which nobody expects, including me, is that the private sector picks up that fumbled ball and actually starts to do something. I do not buy the issues of health care and regulatory uncertainty," he said.

There are a few earnings reports in the coming week, and there could be any number of companies commenting on their third-quarter results.

Lennar reports Monday. AutoZone, Carnival, CongAgra, Oracle and Adobe report Tuesday. General Mills and Bed Bath and Beyond report Wednesday. FedEx, Nike, Discover Financial, and report Thursday, and KB Home reports Friday.


Housing data dominates in the week ahead, (all times are New York time):

10 a.m. National Association of Home Builders survey

8:30 a.m. Housing starts

10:00 a.m. Existing home sales
2:15 p.m. FOMC statement

8:30 a.m. Weekly jobless claims
10 a.m. FHFA Home Price Index
10 a.m. Leading indicators
4:30 p.m. Fed balance sheet

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