Is Economy Strong Enough for Fed to Dial Back?
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By Richard Leong,
Reuters
September 1, 2013

Wall Street is bracing for a wave of economic reports next week, including the August jobs report, which might prove decisive in determining whether the economy is strong enough for the Federal Reserve to dial back its bond purchases in mid-September.

Anxiety about the Fed possibly reducing its $85 billion monthly stimulus, also known as QE3, has hurt the stock market, which recorded its steepest monthly fall since May 2012. But the stock market's greater anxiety, which has developed in recent weeks, is that the Fed will press ahead with a reduction in support, even as the economy remains fragile.

The recent data has failed to provide evidence of the convincing growth the Fed says it wants to see. Until then, stocks will benefit from the cheap money resulting from the Fed's bond purchases.

"Next week's data should make or break the September expectations," said Mike O'Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut.

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A strong jobs report will likely reinforce the view the Fed will opt to decrease its bond purchases at its September 17-18 meeting, while a weak one would do the opposite, analysts said.

"From a real economy perspective, QE3 has done very little. From a financial markets perspective, it has had a major influence. If it is really not helping the real economy beyond pushing financial assets higher, there is no point in continuing the risk of increasing the balance sheet," said O'Rourke.

For the month, the Standard & Poor's 500 index fell 3.1 percent in August; the Dow Jones industrial average lost 4.4 percent and the Nasdaq slipped 1 percent.

Speculation on the timing of Fed action has triggered a bond market sell-off that sent mortgage rates to two-year highs. The surge in home borrowing costs this summer has shown signs of slowing the housing recovery. Analysts also are watching if the higher rates have discouraged employers from adding workers.

Economists polled by Reuters forecast domestic employers likely hired 180,000 workers in August, more than 162,000 in July, while the jobless rate likely held steady at 7.4 percent, which is a four-year low.

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Deutsche Bank economists said that if the payrolls figure exceeds 190,000 and the unemployment rate falls to 7.3 percent, they expect the Fed will start cutting bond purchases. "August employment would have to meaningfully disappoint for the Fed to back away from the timetable presented by Chairman Bernanke in the June post-meeting press conference," they wrote.

Prior to the payrolls data on Friday, traders will face a heavy schedule of economic releases after the three-day holiday weekend. They include the latest readings on vehicle sales and national factory and service activities. U.S. financial markets will close on Monday for the Labor Day holiday.

Investors are watching the tense situation between the West and Syria. Signs of a U.S.-led military strike against Syria after chemical weapons were used to kill civilians could hurt the appetite for stocks globally.

Traders pared expectations on such a move after the British parliament voted against a military strike. But France said it supported punishing Syria for the attack on civilians. U.S. Secretary of State John Kerry said on Friday the chemical weapons attack in Damascus last week killed more than 1,400 people. Despite the sharp moves in equities due to the Syrian unrest, "we still expect the market to stop short of a 10 percent decline," said Mike Dueker, head economist for North America at Russell Investments in Seattle.

Light volume in late summer likely exaggerated August's stock decline, analysts said. The uncertainty has also boosted measures of volatility. The CBOE Volatility Index rose above 17 on Friday, a two-month high. Bonds, in comparison, posted small losses. They were poised to lose 0.54 percent in August, according to Barclays' Aggregate bond index that tracks U.S. investment-grade debt returns.

SHAKY SEPTEMBER
While Syria and economic data will be next week's main concerns, other developments, such as President Obama's nominee to succeed Ben Bernanke as Fed chief and another possible showdown between Obama and congressional Republicans over the federal debt might keep investors on edge, analysts said.

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"There is no doubt September is teed up for a tsunami of data coming at us and headlines coming at us," said David Lyon, investment specialist at JP Morgan Private Bank in San Francisco, which manages $910 billion in assets.

"So the market will look at September and really start to find its footing based on some of the economic data that comes out as well as clarity around policy decisions at the central bank level or the geopolitical level," he said.

History might complicate that view. September has traditionally been the worst month for stocks, with an average 0.6 percent decline in the S&P 500 index over the past 62 years, although it rose 2.4 percent last September. This September marks a milestone - the five-year anniversary of the global credit meltdown during which Wall Street witnessed the downfall of Lehman Brothers, the sale of Merrill Lynch, the near-demise of insurance giant AIG.

In that turbulent September 2008, the market tumbled 9.1 percent.

With additional reporting by Chuck Mikolajczak and Rodrigo Campos, both of Reuters.