Wednesday, October 29th, Market Update

Wednesday: 10/29/08 5:00 PM EDT :
Market Update:

The latest Federal Reserve rate cut initially gave a boost to Treasuries and sent stocks into negative territory. But stocks rebounded and looked as if they were going to post more strong gains following yesterday's impressive rally. This took the wind out of the bond market's sails -- at least at the long end of the maturity spectrum -- and prices wound up mixed. Bond trading closed before traders could react to a late-session fall in stocks that also resulted in a mixed finish. In late trading, the 10-Year Treasury Note was down by 5/32, raising its yield by 2 basis points to 3.85%; the Dow was down by 74.16 points to 8,990.96; and the Nasdaq was up by 7.74 points to 1,657.21.

Both markets were generally subdued prior to the Fed announcement. The economic news of the day was not a market-mover in any case. The level of durable goods reportedly rose last month. While observers had anticipated a decline, August's drop was revised to the largest in twenty-two months. In addition, key subcategories (ex-transportation, ex-defense, and ex-defense capital goods minus aircraft) showed a second consecutive month of contractions.

At about 2:15 PM Eastern Time, the Fed released its policy statement. As predicted, the FOMC voted to cut its target for the fed funds rate by 0.5% from 1.50% to 1.00%. The last time the rate was as low was between June of 2003 and June of 2004.

The committee also cut the discount rate by 0.50% from 1.75% to 1.25%. The statement acknowledged the economic slowdown and turmoil in the financial markets. Though the Fed has done much to address the problems, it admitted that there are still downside risks to the economy, thus leaving the door open for more rate cuts if necessary.(FOMC STATEMENT)

Although the action was well-anticipated, a sizeable market response was not too surprising since some bond traders may have unwound defensive positions taken prior to the announcement and some stock traders who bought on the expectation may have felt it wise to sell on the news. But a rate cut also helps stocks by lowering borrowing costs for businesses and consumers. Stocks quickly recovered their footing and moved sharply higher.

During the afternoon rally, the Dow was up by as much as 296.92 points or 3.28%. But the late-session plunge left it with a loss for the day of 0.82%. The S&P 500 had been up by 3.10% but finished down by 1.11%. The Nasdaq was able to finish with a gain of 0.47% but it had been up by as much as 3.40%.

A contributing factor to the sharp drop at the end of the day was the release of negative earnings guidance from General Electric. Its stock fell from a better than 2.5% gain to a loss of 1.49% in fifteen minutes.

Another factor may have been a rise in oil prices. Though increases benefit the energy sector of the stock market, they also increase production and transportation costs. The Energy Information Administration reported today that inventories of crude oil edged up last week by 493,000 barrels (one barrel equals forty-two gallons). The increase was a fifth consecutive expansion but the smallest of them. Yet, the latest level (311,873,000 barrels) was the highest since mid-May and supplies were 1.2% above where they stood a year earlier -- the highest Y/Y margin since August of last year.

The report also said that inventories of distillates, which include diesel and heating fuel, rose by 2.3 million barrels. Supplies were still 5.8% below year-ago levels, though this was the best Y/Y margin in six weeks.

Of particular concern was a 1.5 million barrel decline in gasoline inventories following four weeks of increases. The inventory level was 2.0% below where it was a year earlier. By the end of futures trading, the price of a barrel of light, sweet crude oil for December delivery had risen by $4.77 on the New York Mercantile Exchange to settle at $67.50. The jump was the largest since September 22.

Tomorrow brings the jobless claims report and another glimpse of the employment situation. In last Thursday's report, the Labor Department reported that the seasonally adjusted level of initial claims for state unemployment benefits rose the week before by 15,000 to 478,000. The report revised the previous week's figure of 461,000 up by 2,000 to 463,000 and for the week ending October 4, the previously reported figure of 477,000 was revised up 4,000 to 481,000. The latest reading was the fourth highest since March of 2002.

But the latest increase followed two weeks of declines totaling 36,000 which followed three weeks of increases totaling 54,000. The four-week moving average, which smoothes out some short-term volatility, declined by 4,500 to 480,250, but this was still the third highest reading since October of 2001.

For the first forty-two weeks of the year, the average weekly claims reading has been 393,810. For the same period last year, the average was 317,167.

The report said that continuing claims declined by 4,500 to 3.720 million in the week ending October 11 (continuing claims must be at least a week old). This was the second highest reading since June of 2003. The four-week average rose by 44,250 to 3.680 million, the highest reading since July of 2003. For the first forty-one weeks of the year, the average continuing claims reading was 3,119,854. For the same period last year, the average was 2,527,804.

Also out tomorrow morning is the advance report on gross domestic product (GDP) for last quarter (Q3: July - September). GDP is the market value of all final goods and services produced by labor or property in the country in a year?s time. Quarterly data is adjusted and annualized and changes from quarter to quarter indicate the strength and direction of the economy.

According to the final report for the second quarter, GDP grew at a 2.8% rate, a downward revision to the preliminary report of 3.3%, but up from the advance report of 1.9%. It was still the strongest reading in three quarters.

But recent economic data suggests that GDP fell last quarter and forecasters are predicting a reading between -0.5% and -1.0%. Some optimists are calling for a flat reading (0.0%). More supply comes to market tomorrow as the Treasury will be conducting its monthly auction of 5-Year Notes. Last month's issue met with modest demand but, once again, the offer amount was exceptionally high. The face value was $24 billion, the highest since February of 2003. Bids exceeded the offer amount by 1.91 to 1, the lowest bid-to-cover ratio in four months. The average for the twelve auctions preceding September's was 2.26.

Noncompetitive bids, a gauge of individual investor demand, totaled about $105 million. Though this was above the twelve-auction average of $93 million, it was down from August's $124 million and as a percentage of the offer amount was the smallest of the last five auctions.

Foreign demand was so-so. Indirect competitive bids received 26.6% of the issue, down from August's award portion of 29.6% but in line with the twelve-auction average of 26.7%. Tomorrow's offering also has a face value of $24 billion.

Wednesday Morning Update10:30 AM EDT:
The financial markets are in a holding pattern as traders await the outcome of the Fed's monetary policy meeting. The stock indices are down in early trading but losses are slight so far -- a possible sign of strength given the likelihood of some profit-taking following yesterday's strong rally.

Treasuries are currently narrowly mixed with the long end of the market down from earlier highs.
The major economic release of the day was more bullish than anticipated but it contained some bearish details. The Commerce Department reported that the seasonally adjusted level of durable goods orders rose last month by 0.8%.

Durable goods are defined as items meant to last three years or more. They are usually labor-intensive to produce, expensive, and therefore often financed. Because of this, the trend in orders provides some insight regarding upcoming production activity and the effect interest rates may be having on the process.

September's advance was a stronger than the 1.0% decline that analysts had predicted. But August's previously reported decline of 4.8% was revised to a deeper contraction of 5.5%, making it the biggest decline since October of 2006. A major contributor to last month's improvement was a 6.3% jump in transportation orders, the largest increase since last February. Orders for commercial aircraft rose by 29.7%, the largest increase in a year. Orders for motor vehicles also saw a 3.0% increase following an 8.8% decline in August.

But excluding the large but volatile transportation category, orders fell in September by 1.1% following a 4.1% decline in August. August's drop was the largest since January of 2002. Another closely watched category is orders outside of the defense sector since defense orders are not governed by standard market forces. Ex-defense orders declined by 0.6% following a 6.0% drop in August. Defense orders rose by 22.8% in September.

The category of ex-defense capital goods minus commercial aircraft is another key category as it is seen as a gauge of core business demand. The order level fell last month by 1.4% following a 2.2% decline in August.

In industry news this morning, the Mortgage Bankers Association of America said that its mortgage application index rose last week by 16.8%. This followed a decline the week before of 16.6%. The purchase index rose by 8.5% following a decline of 10.9% and the refinance index jumped by 28.5% following a plunge of 23.5%. Refinances accounted for 46.9% of all application activity last week, up from 42.6% the week before. Applications for adjustable rate mortgages represented just 1.9% of applications, down from 2.7% a week earlier.

Of course, the major event of the day is the conclusion of the Fed's two-day, monetary-policy meeting. On the eighth of this month, the policy committee cut its target for the overnight borrowing rate between banks (fed funds rate) by 0.50%. It also made a same-sized cut to the rate charged to banks for loans directly from the Fed (the discount rate). Since August of last year, the discount rate has been cut ten times for a total of 4.00% from 6.50% to 1.75%. Since September of last year, the fed funds target has been cut eight times for a total of 3.75% from 5.25% to 1.50%. In addition, the Fed has also instituted numerous new programs designed to keep credit flows moving.

Despite all of these measures, most observers believe that the committee will vote to cut rates once again by 0.50%. If the prediction is true, it would likely move the markets since traders are likely calculating an uncertainty factor into their pre-statement positioning. But any different outcome from the meeting would have an even greater impact on the markets.

The policy statement will be released at around 2:15 PM Eastern Time. The results will be posted here when they become available . . . .