FOMC: Business as Usual

As anticipated, the Fed kept the federal funds rate within their 0.25% target and made no adjustments in the amount of their asset purchases. Team Bernanke noted that economic activity has picked up its pace while conditions in the financial markets continue to improve. They echoed most of their comments from the August meeting and said that they will continue to employ a wide range of tools to promote economic recovery and price stability. None of this surprised me – it’s not like we haven’t heard this before!

According to them, inflation would remain subdued for the meantime since they believe that the output gap should keep a lid on price hikes. This is accompanied by their typical note of caution; saying that ongoing job losses, sluggish income growth, and tight credit would constrain the nation’s economic recovery. They pointed out that businesses are still cutting back on investment and hiring, though, at a slower pace this time.

The Fed will continue its $1.25 trillion plan to purchase asset-backed securities, but they mentioned that they would be extending the pace of these purchases from December to March. Some experts believe that the extension of the asset purchase would smoothen out the injection of money to the economy.

Is the Fed correct in their claims that the economy is headed towards recovery? With the Fed phasing out their stimulus measures, could this mean that a return to normal market conditions is in order? Let’s take a look at some recent data…

The ISM manufacturing PMI, an indicator of how the manufacturing industry is faring, finally busted out of its rut and posted a reading of 52.9. A reading above 50 means the manufacturing industry is expanding. This was the first reported expansion since June 2007.

Retail sales also grew unexpectedly in August. The core report, which excludes the price of volatile items such as automobiles, almost tripled forecasts. It showed a whopping 1.1% gain instead of the 0.4% consensus. Looking beneath the headline figure, the gains primarily came from the increased purchases of general merchandise and clothing.

These positive data seem to indicate that the Fed’s programs to unfreeze tight credit markets, such as the cash-for-clunkers and asset buy-back program, have finally worked their magic. Still, there are two very important issues are really weighing down on recovery – employment and housing.

Let’s start with the labor market. Weekly initial jobless claims have been showing improvements as of late. This past week showed an unexpected drop to 530,000, down from 550,000 the previous week. This brought claims down to its lowest level in two months. In addition, the most recent NFP employment change report showed that firms only slashed about 216,000 workers, better than the 276,000 jobs lost in the previous month.

What’s interesting here, however, are the negative revisions in all the previous results. And despite the “improvements” in the mentioned accounts, the jobless rate in the US still rose to 9.7% from 9.4%.

A more daunting number is reflected in the so called under-employment rate. This rate includes part-time workers who prefer a full-time position but cannot find one and people who want work but are already discouraged to keep searching. As it is, the figure stands at a whopping 16.8%!

As for the housing market, data released last Thursday indicated that sustainable recovery might take a while, as there was a surprise drop in existing home sales in August. The annualized number of home sales unexpectedly slid by 2.7% from 5.25 million in July to 5.10 million this past August. This marked the first drop in 5 months.

Digging deeper, about 30% of the total home sales in July and August were from first-time buyers. And in case you didn’t know, an $8,000 tax credit was given to first-time home buyers in an effort by the government to boost residential property sales. Note that the Fed’s mortgage-backed securities purchase program accounts for about 80% of the market.

Without tax credits and a longer asset-purchase allocation, how will the housing market fare?

Okay, now let’s get to the good stuff, the stuff all you forex freaks have been waiting for: What does all this mean for the dollar?

Just this past week, we’ve seen the dollar hit some lows against higher yielding currencies. The EUR, CHF, AUD, CAD and NZD have staged stellar rallies as they took advantage of USD weakness. But after the Fed announcement, the USD finally fought back.

After the lackluster Fed meeting, is it possible that currency traders have realized, once again, that they have overextended themselves? I don’t know but with the earnings reports coming up soon, we could see some drastic changes in risk sentiment!

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