As the S&P 500 and Dow Jones inch closer to 2012 highs following the tail end of U.S. corporate earnings season, the U.S. market is poised to take its next cues next week from Europe and the Federal Reserve for signs about the sustainability of the 6 week rally in equities.
The clear direction of the U.S. equity market has been in an upward trajectory following improving U.S. economic data which includes a brightening employment picture with a better than expected 163,000 new jobs added in July, improving retail sales figures with a slight .08 gain, a stabilizing housing market, and improving consumer sentiment.
Another important catalyst behind the equity surge are expectations of further monetary easing measures undertaken by the U.S. Federal Reserve.
On Wednesday the Federal Reserve will release the Fed Minutes which is expected to hold some possible clues about the willingness of the central bank to engage in further monetary easing measures.
Federal Reserve Chairman Ben Bernanke previously suggested that the Fed Reserve will undertake further stimulus as a “last resort” to stimulate the U.S. economy.
The Federal Reserve has held short-term interest rates near zero since December 2008.
To reduce long-term rates, it has accumulated more than $2 trillion in government debt and mortgage backed securities.
In September 2011, the Fed announced plans to lower long term interest rates through an operation called “Operation Twist,’’ whereby the Fed purchases $400 billion in long-term Treasury securities from the sale of short-term government debt.
In June 2012, the Fed decided to extend “Operation Twist” for six more months through the end of 2012 by purchasing $267 billion in long term securities. The Fed announced it stood ready to take further action to put unemployed Americans back to work.
On August 1st the markets reacted negatively after discovering the FOMC press release which showed the Fed had no immediate plan to engage in further monetary stimulus.
However, the release noted “strains in global financial markets continue to pose significant downside risks to the economic outlook.”
Many economists believed that the Fed needs more economic data to confirm or deny the need for further stimulus measures. The August jobs report will be closely watched to determine whether the jobs market is moving in the right direction on a sustained basis.
Speculation has been building since August 1st that the Fed may launch some added stimulus measures (QE3) to assist the U.S. economy and lower the stubbornly high unemployment level which remains locked at 8.3% despite a better than expected July jobs report and overall improving U.S. economy which typically lessens the necessity for further stimulus measures.
Big moves in gold are closely tied to central bank actions.
Some big hedge fund managers like John Paulson have been raising his stake in a gold exchange traded fund, betting that the price of gold will increase with the adoption of future stimulus measures undertaken by the Fed Reserve.
While gold rises in a climate of quantitative easing by the Fed, the U.S. dollar typically weakens in the midst of monetary stimulus measures such as QE3, impacting the commodities market and the outlook for U.S. products in the international market.
Although the U.S. economy is showing signs of an economic rebound, the global economic slowdown is still very much underway across Europe and Asia.
In Asia the economic slowdown is most notably apparent in contracting Chinese GDP, weaker manufacturing growth, and a slowing Japanese economy.
Last week, Japan economic ministry announced that Japan’s economy grew at an annualized rate of 1.4% in the second quarter, lower than an estimated 2.7% by economists and a serious decline from a revised 5.5% expansion in the prior quarter.
Latest economic data last week out of France and Germany, the two strongest economies in the Euro area, showed that France and Germany had smaller levels of quarterly contraction than first estimated. German GDP grew .03, a slight beat from estimates of .02 but still down from .05 in the previous quarter. France’s GDP was unchanged in the second quarter but strong enough to surpass estimates of a .01 decline.
However, the greatest concern in Europe centers around the debt ridden economies of southern Europe such as Greece, Spain, and Italy.
On Friday in Greece the central government disclosed that its debt reached € 303.53 billion as of June 30, rising by € 23.2 billion from March 31st.
The higher debt level comes to light in the midst of new calls from Greek PM Antonis Samaras for more time to implement EU austerity programs.
PM Samaras will meet with German Chancellor Angela Merkel on Aug. 24 in Berlin and French President Francois Hollande on Aug. 25 in Paris to campaign for an easing of bailout terms that includes two more years for Greece to execute international bailout terms.
In October Troika financial inspectors will provide a detailed report about Greek compliance with their international bailout package.
Finland’s foreign minister, Erkki Tuomioja told Britain’s Daily Telegraph on Friday that European leaders must prepare for the possibility that the euro area breaks up.
As Finland’s population shifts to euroskeptic parties such as True Finns, there is less support for Finnish taxpayer money being used to support debt ridden countries like Greece and Spain.
“Taxpayers here are extremely angry,” said Timo Soini, leader of True Finns.
“There are no rules on how to leave the euro but it is only a matter of time. Either the south or the north will break away because this currency straitjacket is causing misery for millions and destroying Europe’s future.”
“It is a total catastrophe. We are going to run out of money the way we are going. But nobody in Europe wants to be first to get out of the euro and take all the blame,” he said.
Finland has veto power that could be used to block any new bail-out measures since its parliament would have to approve every future measure of a euro area rescue package.
Meanwhile, German Finance Minister Wolfgang Schaeuble has recently ruled out another aid program for Greece despite its contracting economy, according to Bloomberg.
“It can’t be helped …. we can’t make yet another new program,” Schaeuble was quoted as saying to visitors in Berlin.
The German Constitutional Court is expected to decide on September 12th whether German taxpayer money could be used to support Europe’s future rescue fund, ESM, and whether Germany can support a fiscal pact.
The European Stability Mechanism (ESM) plans for a fiscal pact requires the approval of all euro area countries. Although Germany’s parliament has already approved the pact, there remains some legal challenges with Germany’s Constitutional Court.
U.S. Economic Challenges
Despite the global slowdown and uncertainty in Europe, stronger than anticipated economic data has pushed the stock markets higher while sending the price of benchmark crude oil higher, resulting in some legitimate concerns about higher gas prices hurting discretionary retail spending levels in the U.S. economy next quarter.
Gas prices in the U.S. have already climbed .39 cents since the beginning of July. Gas prices have risen .18 cents in only 2 weeks. The cost of gas has risen 23% since June.
One of the reasons that retail sales showed a gain of .08 in July is due in part to Americans paying less for gas. But that trend could be compromised if gas prices continue to climb higher to $4.00 a gallon.
Last week, reports surfaced in the media that President Obama may release U.S. strategic petroleum reserves to help offset the rising oil costs which could potentially jeopardize a U.S. economic recovery.
The price for Brent crude fell as much as 2 percent to below $113 a barrel on news the United States was weighing a release from its reserves then gave up some of the losses after the executive director of the International Energy Agency, Maria van der Hoeven, said “There is no reason for a release.”
* Corrected- earlier today it was falsely reported in the last sentence of this post: the United States was weighing a release from its reserves then gave up some of the ‘gains’ instead of ‘losses’ after the executive director of the International Energy Agency, Maria van der Hoeven, said “There is no reason for a release.”