U.S. Market Preview

U.S. Market Preview

Asian stocks today closed with some sharp losses as the markets played catch-up to last Friday's sharp losses on Wall Street due to the weak US Aug payroll report. The Nikkei index today closed -2.22% and Australia closed -1.39%, although Hong Kong closed +0.07% and China's CSI 300 index closed +1.56%. The European DJ Stoxx 50 index is down only -0.15% this morning, suggesting that the immediate fall-out from last Friday's US payroll report may be over.

This week’s US economic calendar is relatively light following last Friday’s unemployment report. Today brings the July consumer credit report (expected +$9.1 billion). Tomorrow brings the July US trade deficit report (expected slightly wider at -$59.0 bln vs -$58.1 bln in June). Wednesday brings the weekly MBA mortgage applications index. Thursday brings weekly unemployment claims, the Treasury’s 10-year T-note auction, and the Aug Treasury monthly budget statement (expected -$79.5 bln). Friday brings Aug retail sales (expected +0.5% overall and +0.3% ex-autos), Aug import prices (expected +0.3%), Q2 current account deficit (expected slightly narrower at -$190.0 bln vs -$192.6 bln in Q1), the early-Sep US consumer confidence index from the University of Michigan (expected +0.6 to 84.0), and July business inventories (expected +0.3%).

The market is mainly looking ahead to next Tuesday’s FOMC meeting, which is expected to produce at least a 25 bp rate cut in the funds rate target to 5.00%. There is only a remote chance that the Fed will cut rates prior to next week’s meeting due to last Friday’s disappointing July payroll report of –4,000. Philadelphia Fed President Charles Plosser said in an interview this past weekend that the surprise Aug payroll report showing a loss of jobs was “not encouraging.” However, he said that “We want to be careful not to overweight one piece of information” in making a rate decision and that “I’ve not made up my mind at all” on whether a rate cut is needed. He added that, “all of August’s numbers are going to be a little noisy” and that “We need to take some things with a grain of salt. Retail sales numbers were pretty good.” Mr. Plosser is not an FOMC member, but his comments suggest that Fed members are not being lobbied by Mr. Bernanke for an emergency Fed rate cut before the Sep 18 meeting and that the Fed plans to stick to its schedule of considering a rate change at the Sep 18 meeting.

The market is currently discounting a 100% chance of at least a 25 bp rate cut to 5.00% at next Tuesday’s FOMC meeting. The market is discounting an average 4.81% funds rate average in October, which means that the market is discounting either a 76% chance of a 50 bp rate cut on Sep 18, or that the Fed will only cut the official target by 25 bp to 5.00% but then inject sufficient reserves during the month to keep the funds rate average trading an average of 19 bp below the new 5.00% target during October. Either way, the market is expecting the Fed to pursue a de facto 4.81% funds rate average in September.

The Fed is not currently paying much attention to its official 5.25% funds rate target as it battles the banking crisis with temporary reserve injections. The Fed pushed average daily funds rate down to the 4.60% to 5.00% area in the 2 weeks immediately after the banking crisis (which began on Aug 9), and the funds rate average in the past 2 weeks has been in the range of about 5.00-5.25%, just mildly below the 5.25% funds rate target.

Looking ahead, the market is discounting an overall 100 bp rate cut to 4.25% by year-end and nearly an overall 125 bp rate cut by next summer. A 100 bp rate cut in the pace of a few months represents market expectations for a dramatic move in Fed policy. The extent of the expectations for Fed easing suggest that the market believes that a US recession is now fairly likely.