The Day Ahead: Markets Upbeat as FOMC Prepares Statement
Market focus will be on the Federal Reserve today as traders wait to see whether the Fed will engage in further quantitative easing. The expectation is for some form of Operation Twist - a fancy name for a basic move of redeeming short-term notes and reinvesting in intermediate bonds.
The 10-year yield is at 1.92%. The 30-year yield is steady at 3.20%.
Equity markets are relatively upbeat in early trading, quite unlike the final hour of trading on Tuesday when the market retracted most of its gains.
S&P 500 futures are 2.7 points higher at 1,198.70 and Dow futures are up 25 points at 11,360.
The European session is less upbeat: the FTSE 100 is down 0.44%, the CAC-40 is 0.91% lower, and the Euro Stoxx 50 is off 0.80%.
Light crude oil fell 0.38% overnight to $86.58 per barrel, and gold prices rose 0.27% to $1,813.90.
Key Events Today:
10:00 - July's 3.5% decline in Existing Home Sales is expected to reverse in August. The consensus expects to see a 3.5% advance to 4.80 million units, with forecasts ranging from 4.50 to 4.92 million. Optimistic predictions are largely based on the pending home sale index, which looks at contracts that have been signed but not finalized; lately, however, pending sales haven't translated into actual sales at the usual pace, causing some uncertainty for this index.
"Through the first seven months of 2011, pending and existing home sales have diverged by an average of 2.8%, suggesting that increases in pending sales simply aren't translating into the closed purchase contracts measured by the existing sales series," said Janney Capital Markets. "That divergence, driven by appraisal and mortgage credit problems, reduces the usefulness of the most efficient predictor of housing activity, pending sales, from consideration in estimating existing figures."
Underlying trends, Janney suggested, are troubling at best given high inventories and low demand.
"We see the supply/demand imbalance remaining even after the foreclosure-driven forced selling begins to slow, meaning weak housing markets into 2013 at this point," Janney said. "On the positive side, the Fed's Operation Twist proposal, which we believe will see the light of day, would have the effect of lowering mortgage rates, thereby increasing housing affordability."
IHS Global Insight points out that the Mortgage Bankers Association's purchase index fell for the fifth straight month in August when it plunged 11.9%.
"Demand to buy homes is falling, even as mortgage rates have dropped to record lows," IHS noted as they forecast a 1.3% decline to a 4.61-million-unit annual rate.
Fannie Mae's 30 year mortgage rate averaged 3.79% in August, meaning the average property is about 8% more affordable versus year-end 2010, according to Janney.
"That affordability," they concluded, "just doesn't seem to be enough, however."
2:15 - The surprise in August 9's FOMC Statement was the adoption of a specific timeline for keeping rates low (the Fed said rates would remain "exceptionally low" until "mid-2013). The question this time is whether the Fed will enact further measures of monetary accommodation.
"Three main options appear to be on the table," said IHS Global Insight, listing "Operating Twist," cutting interest rates on bank reserves at the Fed, or another round of quantitative easing.
"The one most likely to be adopted on Wednesday is the 'twist', because it's the least likely to meet resistance from the more hawkish voices at the Fed," IHS said. "The idea of the twist is to put downward pressure on long-term interest rates, although it is unlikely to have a big effect, especially since the markets have seen it coming. We believe that more quantitative easing is too controversial for now, especially since the hawks will have taken note that core CPI inflation has now reached 2.0%, but that it will come eventually because we expect growth to remain weak and the unemployment rate to rise."
Deutsche Bank explains the twist like this: "This would entail either passive reinvestment or active rotation into longer-maturity Treasury securities with the intention of flattening the yield curve. This allows policymakers to reduce longer-term interest rates without further expanding the Fed's portfolio. As a result, policymakers can deflect claims of 'money printing' through balance sheet expansion. We are somewhat skeptical of the magnitude of benefit from such actions, since longer-term interest rates are already extremely low."