It was a breakthrough week — the Dow passed 13,000, Nasdaq broke 3,000 and the S&P 500 passed 1,400. The S&P is now up 11.65% for the year. The biggest gain came on Tuesday, when 15 of 19 major banks passed the Fed’s stress test.
J.P. Morgan (NYSE:JPM) led the financial stock rebound by announcing a 20% dividend increase and a massive $15 billion stock-buyback program. Bank of America (NYSE:BAC) also passed the Fed’s stress test, but Citigroup (NYSE:C) and three others were told to resubmit their capital plans.
The Fed Ignores Inflation, Favoring ZIRP, Twist & QE3
The market’s big jump on Tuesday was due to two pieces of bullish news, both emanating from the Federal Reserve: (1) the net-positive bank stress test and (2) the upbeat official statement following the latest Federal Open Market Committee (FOMC) meeting, in which the Fed acknowledged that the unemployment rate “has declined notably” but said the recovery was not strong enough to change its 0% interest rate policy (ZIRP), which began in late 2008 and will last until “at least late 2014.”
Six years of low-cost money seems to be a reckless and inflexible promise considering that inflation is rising again, due mostly to higher crude oil prices. Apparently, the Fed still insists that higher prices at the pump are temporary and will not lead to long-term inflation. In fact, the Fed left open the possibility of a third round of quantitative easing (QE3) after Operation Twist — trying to flatten the yield curve — ends.
The Fed can manipulate short-term rates, but it’s having a harder time flattening Treasury yields on the long end. With inflation brewing, Treasury yields rose faster last week than in any week since last October, just before the Fed implemented Operation Twist to squash the yield curve.
Last Wednesday, a 30-year Treasury bond auction pushed yields up 15 basis points, to 3.42%, the biggest one-day increase since last October. The 10-year bond and five-year note yields rose by 15 and 12 basis points, respectively. Clearly, the bond market anticipates rising inflation, even though the Fed minimizes any inflation threat.
Stat of the Week: Inflation Indexes Rise 4.9% (Annual) in February
On Thursday, the Labor Department confirmed that inflation is brewing on the wholesale front when it announced that February’s Producer Price Index (PPI) rose by 0.4% (a 4.9% annual rate). The core PPI, which omits food and energy, rose 0.2%.
While gas at the pump seems to be soaring, a 14% drop in the price of natural gas meant that overall energy costs rose by only 1.3%. In addition, wholesale food costs fell 0.1% for the third straight monthly drop. Overall, the PPI is up 3.3% in the past 12 months.
Then, on Friday, the Labor Department reported that the Consumer Price Index (CPI) rose by the same 0.4% in February, but the core CPI rose by only 0.1%, giving the Fed an excuse to keep key short-term interest rates near zero. In the past 12 months, the CPI is up 2.9%, so it is rising a bit more slowly than the PPI.
Even though overall inflation seems to be under control, the price of gas is where most Americans get their inflation warning. The price of gas seems to control consumer sentiment. On Friday, the University of Michigan/Reuters announced that its preliminary reading for consumer sentiment in March declined to 74.3 from 75.3 in February.
The report also said that inflation expectations have risen to 4% (per year) in March, up from 3.3% in February, due largely to higher gasoline prices. But the good news is that consumers remain optimistic about the job market, and higher stock prices usually lift consumer spirits.
Despite the distraction of higher oil and gas prices, the Commerce Department announced Tuesday that February retail sales rose 1.1%, the highest level in five months. Also, January’s retail sales were revised higher, to 0.6%. Excluding strong vehicle sales and gasoline sales, retail sales still rose 0.6% in February — a sure sign of rising consumer confidence, which also bodes well for GDP growth.