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Sunday, March 16, 2008

The Week Ahead: Fed Cuts and Bank Failures

Despite the news from Bear Stearns and a weak retail sales report, the Dow actually ended the week up 0.48%. Nonetheless, there isn’t much else to boast about; the NASDAQ ended unchanged while the S&P500 lost 0.40%. However, the CPI release surprised the market by coming in well below expectations and showing no increase for either the core or headline indices. This development was mostly sidelined by the problems at Bear.

But looking forward; this week it’s all about the Fed. Despite the encouraging CPI report the Fed will not view one month’s data as the beginning of a trend; they will remain very vigilant over inflation. However, the news from Bear Stearns and growing trouble in the financial sector will cause the Fed to cut rates by 75bps. We do not believe the Fed will move a total of 100bps given their current concerns over inflation. If the Fed was to move a total of 50bps verses 75bps and the market reacted adversely it would potentially open the window for an additional inter-meeting rate cut, which the Fed would like to avoid. As we have said before we feel one of the best indicators for the Fed’s move is what the market is currently pricing in. The Fed typically does not disappoint the market. (For a more detailed analysis on Fed cuts and inflation please look at our posts from March 11th titled “Inflation, Inflation, Inflation” & February 27th titled “Fed Cuts & Inflation”)

Effective Fed Funds rate pre-March 2008, implied Fed Funds rate post, as of March 14th.

Monday March 17th:
8:30AM: Empire State Manufacturing Survey (Risk: Neutral) The Bloomberg consensus survey indicates the market is currently expecting a reading of -6.3, this would be an improvement from last’s month unexpected drop to -11.7, but still in negative territory. This survey is one of the first indicators monthly indicators released covering the manufacturing sector and thus it is used as a tool to help forecast the overall ISM number. A negative reading of this survey combined with negative readings from the Philly Fed and the Chicago-NAPM can indicate a slowdown in the ISM.

9:15AM: Industrial Production (Risk: Downside) The Bloomberg consensus survey indicates the market is currently expecting a reading of -0.1% on production and a 81.3% capacity utilization rate, compared to 0.1% and 81.5% on production and capacity utilization, respectively. The recent slowdown observed in manufacturing could adversely impact production.

Tuesday March 18th: Fed Day!
8:30AM: Housing Starts (Risk: Downside)- According to Bloomberg.com the market is currently expecting housing starts to total 0.99mn. Permits continue to decline, inventories continue rising, we just don’t see much upside potential for this indicator. (For more information please read our post on the Housing Crisis from March 5th titled ‘How will it end?’)

8:30AM: Producer Price Index (Risk: Neutral/Slight Upside)- According to Bloomberg.com the market is currently expecting PPI and Core PPI to increase 0.4% and 0.2%, respectively.

2:15PM: Fed Announcement (Risk: Neutral/Slight Upside)- We expect the Fed will cut rates by 75bps and continue to hold a negative bias. We expect the Fed will indicate that they will continue monitoring inflation, and that downside risks to growth still exist and will continue to affect employment. They may also mention in more detail their concerns about the financial sector after the Bear Stearns bailout and surprise rate cut on Sunday.

Wednesday March 19th:

Thursday March 20th:
8:30AM: Jobless Claims (Risk: Neutral)- According to the consensus survey Jobless Claims are expected to come in at 360K, still above our 350K threshold.

10:00AM: Leading Indicators (Risk: Neutral)- Bloomberg.com currently states a market consensus of +0.3% M/M change for the leading indicators.

10:00AM: Philly Fed Survey (Risk: Neutral)- Bloomberg.com indicates the market is expecting a reading -20.0 verse -24.0 last month. As with the Empire Survey being released earlier in the week, the Philly Fed will be the second release to address the health of the US manufacturing sector.

Friday March 21st:
Market Closed (Good Friday)

Investment Idea:

Please look at the posting from March 9th. Also, we have begun looking at long dated Citigroup calls as a possible investment idea. At the same time, we are very concerned about Lehman Brothers and expect to see its shares catch a strong bid.

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