There isn’t much that moves the market like a shift in interest rates by Federal Reserve policy makers. This year, it is beginning to look like the Fed won’t move much.

As central-bank rate setters prepare for their first meeting of the year this week, investors increasingly are resigned to a longer pause in rate moves than previously expected.

Yet it might be that it is the pause that refreshes. In recent years, the stock market usually has performed well when the Fed declines to move up or down, as it has since last summer.

Some Wall Street forecasters say the Fed could go all year without changing its rate targets, a prospect that contributed to the market’s sluggishness last week.

Such predictions run counter to many investors’ hopes for a quick rate cut, which would lower borrowing costs and encourage more consumption throughout the U.S. economy, potentially helping corporate profits and thus stocks.

There is a lingering risk that stocks’ latest rally may already have run its course. The Dow Jones Industrial Average is up 14 percent since the Fed last changed its benchmark rate, raising it a quarter percentage point in late June to 5.25 percent. Many analysts believe the market is likely to remain especially volatile in the weeks ahead as investors rejigger their bets to reflect new rate expectations.

The main reason for bulls’ overall optimism is that, as fourth-quarter reports roll in, corporate profits seem to be doing just fine even without Fed action. Wall Street expects profits at companies in the Standard & Poor’s 500-stock index to rise by more than 10 percent for the quarter — a slower pace than in the previous few years’ boom but still solid growth by historical standards.

“There’s a growing sense among investors that if the economy is OK, then profits will be OK, so I don’t really need the Fed to step in and help me” with lower rates to spur economic growth, says strategist Jack Caffrey of J.P. Morgan Private Bank.

Mr. Caffrey says his firm still expects a rate cut this year, perhaps during the summer if unemployment creeps higher. But that timetable has been pushed back from earlier estimates of a spring rate cut. “The data just weren’t supporting that idea,” Mr. Caffrey says.

Many analysts say the Labor Department’s better-than-expected report on December payroll growth, released Jan. 5, set off hand wringing among investors that the economy might not be slowing enough to justify a rate cut.

Since that report came out, the Dow Jones Industrial Average has floundered, off 0.1 percent despite touching several new records. Last week, as investors continued to shift their rate-related bets, the blue-chip average fell 78.51 points, or 0.6 percent, to 12487.02, up just 0.2 percent this year.

The broad Standard & Poor’s 500-stock index also slipped 0.6 percent last week, off 8.32 points, to 1422.18, up 0.3 percent on the year. The technology-heavy Nasdaq Composite Index fell 0.6 percent, or 15.82 points, to 2435.49, up 0.8 percent on the year.

The Fed’s rate committee will meet Tuesday and Wednesday, with a rate decision due Wednesday afternoon. Futures contracts tracking the likelihood of a Fed move recently have reflected a 98 percent chance the central bank will leave its rate target unchanged, with only a 2 percent chance of a quarter-point cut.

Ethan Harris, chief U.S. economist at Lehman Brothers, has been telling reporters since mid-December that he expects no rate move from the Fed in 2007. If anything, he now says, there is some risk the Fed may raise rates this year, if the current supply of relatively cheap money throughout the global financial system begins to translate into more inflation in the U.S.

“I don’t understand why some strategists are rooting for rate cuts,” says Mr. Harris. “To me, a cut would tell you the Fed is quite worried about the economy. The things that would get them to reach that decision would not be a good environment for stocks.”

If the Fed does indeed keep rates unchanged all year, it would constitute the longest pause since the late 1990s, in the midst of the dot-com boom. Going back to 1989, the S&P 500 index has risen an average 10.1 percent during Fed pauses, not including the current one, according to research firm Thomson Financial.

Mike Thompson, director of research at Thomson Financial, says the key difference between the market now and during the late-1990s is that the market value of stocks relative to their expected earnings hasn’t skyrocketed to unusual levels as it did during the bubble.

That comparison should bode well for the market in the months ahead. Explaining the more fundamental reason that flat rates might help stocks is trickier. One possibility, Mr. Thompson says, is that investors might like Fed pauses for similar reasons to why they tend to like the White House and Congress to be controlled by different political parties.

The common wisdom on Wall Street is that, if the government is divided, it is more likely to result in legislative gridlock, which cuts down on the chance that Congress will do something to hurt business. Likewise, Mr. Thompson says, if investors know the Fed is going to be on pause, maybe they grow confident that the central bank won’t “overshoot” on its rate targets and set off runaway inflation or, even worse, a recession.

Like Lehman’s Mr. Harris, Mr. Thompson expects the Fed to keep its rate targets unchanged throughout 2007. “For them to move, it would take some economic report to come in really, really bad, below what everyone is expecting,” says Mr. Thompson. “It’s hard to see what that would be.”

By Peter A. McKay, The Wall Street Journal 1/29/2007

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NOTE: The views expressed are not of Bonds Financial but of the unaffiliated author.  Bonds Financial Inc. makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.

Posted by bondsblog as FED Watch at 9:04 AM EST

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It’s a massive week ahead filled with first-tier data, weak-month extension needs, the FOMC, and Refunding announcement. These are all broken pieces of glass on top of our bearish “wall of worry.” Yields have hit the lower end of our target range, but we are pushing the goalposts back — certainly to the higher end of that range — and so err on a continued defensive bias.

What’s happened? We have 1) negative price action, 2) a serious restraint from Japan and non-Japan Asia investors (i.e. no buying), 3) achieving these yields so early in the year, with bearish seasonals still upon us, and 4) no great short base. To all this we add that the drop in oil — whether dampening on inflation, but stimulative to growth — reduce the funds oil producers have to invest. The latter is a story that may be part of the lack of overseas buying, of course.

Mitigating factors are there. We’re less concerned with prognostications about the Fed and potential hikes later this year, as the data — while firmer — still looks mixed to us. We are reminded, for instance, of the steady negative prices gains in both existing and new home sales. Also, the lower budget deficit  points to less issuance in H2, that should help offset decline in petrodollar flows. So we have not lost faith in a bullish outcome, but have added MORE patience to what has been our bearish bias. Sentiment is oversold and positions are very marginally short (DSIs, SMR, and Committment of Trades, for instance).

We think the higher end of our targeted range — 5% 10s, 5.05% in 2s — is doable and we’d be covering shorts on the way there. Again, and we emphasize this, we’re as much concerned with the TIMING of weakness as we are with the levels — the seasonals are poor all the way to May. This week certainly provides ample opportunity for such a move. As for upside, we are dubious about a key reversal and rather think there will be a lot of uptick selling, inhibition with into the refunding, and anticipate in February Japanese selling for their FY end.

TACTICAL BIAS: From the US Govt Bond Weekly; The market is in an “interesting” area and if the namby-pamby use of that word disturbs you, imagine our perspective. The upshot is that while we have been bearish, and remain defensive, we have some conflicts. On the one had, yields have reached our objective zone without a great acceleration in either the growth or inflation story. On the other hand, the worst of the seasonal patterns lie ahead — as does the Refunding — and we anticipate Japan selling in Feb/Mar as their fiscal-year end approaches. The firmer dollar aids that potential. In an ideal world, we’d rather see 10s in the 4.90s in a couple of months than there so early in the year.

And so we’ll focus on a more two-way range for now; sell the obvious breakdown areas and buy a move to higher yields. From a strategic perspective we would rather buy strength and momentum than what we’re seeing (covering, toe dipping) and we rather buy in a month or so than right here. The Street has heretofore done a good job of getting auction concessions and we think the Refunding will show the same pattern. The difference then will follow-through.

The week ahead is full of new information, the FOMC, the Refunding announcement,  and is capped on Friday with the NFP report. Consensus forecasts for the latter  have not been great indicators, but without more to go on we can only wring our  hands over the anticipated 140K gain.

OVERNIGHT EVENTS:
* Various ECB hawks out — Weber says ECB must continue to hike, Trichet says money supply (growing at fastest pace in years) needs to examined “very, very carefully,” Bini Smaghi says growth to accelerate again,
* Committment of Traders — specs extend net SHORT, to -122.5k vs. -62K in prior  week. Selling was biggest in FV, with only long in TY (short E$, 2s, FV, and US). Deepest short since mid August.
* Japan, Retail Trade, Dec — slips 0.3% YoY with prior revised lower to -0.2%.
* UK, CBI Retail Sales, Jan — 51% of retailers sold more YoY, vs 21% selling less for balance of 30. Strong.

IMPENDING EVENTS:
* No US Data today

OVERNIGHT FLOWS: The market is mixed with 5s-30s flat to a tad better and 2s-3s a bit weaker for a more inverted curve. The belly is better to the wings. Volumes have been mixed as well with TY at 113% of average but cash at just 65%. 10s take the bulk of market share at better than 40% — very high.

NOTE: The views expressed are not of Bonds Financial but of the unaffiliated author.  Bonds Financial Inc. makes no claim to and regarding the accuracy, correctness or completeness of the views expressed.

Posted by bondsblog as Morning Call at 8:38 AM EST

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It has been called the “Lake Wobegon effect.”  In numerous experiments, a majority of people rated themselves as above average relative to their situation, achievements, and capabilities compared to others.  This phenomenon may be traced to a 1981 survey in which 80% of respondents placed themselves in the top 30% of all drivers.

Mentally, if we reside in Lake Wobegon with a positive attitude, that beats “living down in the dumps.”  A year-end AP and AOL News Poll found 89% of respondents to be optimistic about their own family’s living standards, but less so about “the fate of strangers.”  As the 2008 presidential race heats up, we keep hearing politicians complaining about “the top 1% getting all of the goodies, while the rest of the country-at-large teeters on the brink of financial disaster.”  Writing in The Washington Times (1/21/07), Alan Reynolds notes, “Putting together all the downbeat news with the upbeat poll, what it shows is that 89 percent of Americans must think they’re in the top 1 percent.”

Once people move beyond a “survival mode” and feel self-actualized, they gravitate toward positive outcomes relative to their future.  Buying homes, saving for education and retirement, and improving their standard of living are goals reflected in investment behavior.  Perhaps that is why stock market performance of late has not matched political and journalistic demagoguery.  We are in better shape than the Cassandras of Doom would have us believe.

Take Nobel Prize winning Columbia University economics professor Joseph Stizlitz, quoted by Rich Kalgaard, publisher of Forbes magazine.  In an article gloomily titled, “2007:  Will the Dam Break?,”  Stizlitz sees an economic-Katrina ahead:  “At the root of America’s economic problems are measures adopted early in Bush’s first term. . . The administration pushed through a tax cut that largely failed to stimulate the economy, because it was designed to benefit mainly the wealthiest taxpayers.”

If the esteemed professor was correct, plus adding in the cost of military action in Afghanistan and Iraq, the Federal budget deficit should be soaring.  It isn’t.  It is shrinking!  Tax receipts are surging and the deficit is down by $165 billion over the past two fiscal years, and it is headed lower.  Corporate income taxes were up by over 22% in the first quarter of FY 2007 compared to a year ago.  Rich Kalgaard notes that since the 2003 marginal tax rate cuts on income, dividends, and capital gains, U.S. GDP has expanded by an amount greater than the size of China’s economy!

China, by the way, is being touted as a new superpower rival to a weakened U.S. (See Time, cover story, “China – Dawn of a New Dynasty,” 1/22/07).  Having traveled to China in 2000 and in 2005, this writer has witnessed amazing progress.  But you do not have to wander far to find Third World China.  Even Time writer Michael Elliott calls China “a poor country.”   GDP per capita in 2005 was $1,700 versus $42,000 in the U.S.  The labor market is outpacing job creation; pollution borders on environmental disaster; corruption is endemic; there is no pension system and medical care is available only to those who can pay for it; rural workers are restive and protests are growing.

We hear of U.S. jobs being lost to globalization without job creation being cited, i.e., 9.3 million net new jobs generated since 2001, eclipsing by far the euro zone and Japan.  U.S. employment, business profits, and wages are at record levels.  A contributor to The Wall Street Journal and Forbes, and chief economist for Bear Sterns & Co., Inc., David Malpass, has said, “The U.S. is the world’s biggest producer, exporter, seller, saver and innovator.  On average (this country) adds 30% more to global GDP each year than does all of Asia (45% more in 2006), with one-tenth the population.”

What about trade deficits as a doomsday factor?  Economics professor Walter Williams at George Mason University recently quoted Professor Don Boudreaux, chairman of George Mason’s Economics Department.  In reviewing economic history, Boudreaux declared, “If trade surpluses are so great, the 1930s should have been a booming decade.”

Noting that the U.S. ran trade surpluses in 9 out of 10 years during the Great Depression, Boudreaux asked, “So what do trade surpluses during a depression and trade deficits during an economic boom prove, considering we’ve had trade deficits for most of our history?”

Both Williams and Boudreaux affirm, deficits prove absolutely nothing.  “Economies are far too complex to draw simplistic causal connections between trade deficits and surpluses and economic welfare and growth.”  (The Washington Times, 1/21/07).

Okay, then, what about the looming retirement crisis?  Rich Karlgaard reminds us of a well-circulated and fallacious factoid, one also cited by Professor Stizlitz relative to 2005 – 2006:  “(U.S.) household savings became negative for the first time since the Great Depression.”

Give the professor an F for “fact-checking.”  Misleading data pegging U.S. citizens as profligate spenders and poor savers gives us a black eye around the world.  Based on a U.S. Dept. of Commerce measure, “the government’s bellwether savings measure is flawed because it tracks what is left of Americans’ disposable income each month rather than calculating what people put in bank accounts, brokerages and other places.”  So says Susan Sterne, chief economist of Economic Analysis Associates, Greenwich, CN, who calls the personal savings rate “irrelevant.”  (Pittsburgh Post-Gazette, 2/6/05).

The personal savings rate data does not tally gains in mutual funds, individual stock holdings, 401(K) and other retirement plans, the value of owner-occupied homes, stock options, values of public-sector pension funds, and other assets on American household balance sheets.  The savings rate is far better than it appears, and it is not just that nefarious  “top one percent” that is hogging all of the assets.

As a country we are doing far better than the gloom and doomers would have you believe.  Contrarians know, the more dour the chatter, the better the stock market looks!

Lewis Walker, CFP®, CIMC®, CRC®, is a financial planner and investment consultant with offices in the Forum on Peachtree Parkway in Peachtree Corners; 770/441-2603, lewisw@theinvestmentcoach.com.  Lewis has been elected to the Board of Directors of the Wealth Advisor Institute, headquartered in Washington, DC.

Posted by bondsblog as Financial Planning with Lewis Walker at 8:47 AM EST

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