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Let’s Do the Twist: The Fed Steps in Again

The Fed's move was expected so now focus on company earnings

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There have been a lot of highly anticipated Federal Reserve meetings through the years, but this week’s was one of the most anticipated in quite a while. Ultimately, the Fed did what the market expected, extending “Operation Twist” to purchase $267 billion worth of longer-term Treasury securities (6–30 years) and sell a corresponding amount of short-term ones to keep interest rates low. The program will run through the end of the year instead of expiring at the end of this month.

The market’s reaction was slightly negative initially, with the market declining close to 1%, but then bargain hunters came in to cut the loss to 0.2% on the S&P 500. There may have been some disappointment that the Fed wasn’t more aggressive in launching another round of quantitative easing (QE), but Chairman Ben Bernanke said the Fed would take “additional steps” if necessary in the future, which would almost certainly be more QE. I think the flat response by the market was more a needed pause after the rally leading up to today’s meeting, in addition to a sharp decline in oil prices that hit energy stocks.

Investors had clearly made a strong bet the Fed would do something. The market had rallied over 3% since last Wednesday in anticipation of today’s announcement, and our stocks bounced as well. Also helping matters were the outcome of Greece’s Sunday election, where the party in favor of staying in the eurozone garnered the most votes, as well as hopes that the European Union (EU) would move in the direction of more fiscal and banking unity to stem the current debt crisis.

Along the way, positive expectations for the future trumped a fair amount of bad news. Spanish 10-year bonds are yielding around 7% and were briefly above that level early in the week. And in Greece, although a coalition government has been agreed to as of today, the alliance is no doubt fragile, and the next step is to renegotiate the terms of Greece’s bailout. The government appears willing to continue to work with the EU, but the situation remains serious, as the previous government indicated the country will run out of money by July 20 – one month from today.

Here in the U.S., the news has not been so great either with a string of disappointing economic reports last week. The greatest concern remains the job market. First-time unemployment claims rose to 386,000 last week, and that was followed this week by a larger-than-expected decline in housing starts, though permits did jump. Another indication of weakness was U.S. employers posting the lowest number of job openings in five months. Job openings fell to a seasonally adjusted 3.4 million in April, down from 3.7 million in March.

In the view of Wall Street, however, bad news can be good news. That’s because investors look ahead. The economy has clearly weakened, which made it more likely that the Fed would step in, and step in they did.

So as we approach the midpoint of 2012, the big question facing investors is: Will global issues and a softer U.S. economy translate into disappointing earnings?  They key word there is “disappointing,” which is a relative term. There’s no doubt that part of the reason for the sell-off in April and May was investors pricing in the likelihood that we will see at least some impact on earnings.

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