The Fed Meeting Fallout, US$ Strength / Smaller than Expected Debt Limit Increase, Shadow Home Inventory on the Rise, State Budget Problems

The Fed chose not to change rates or comments during the Wednesday meeting. While we anticipated this outcome in our Monday post, the market reaction has been anything but expected. In months past the type of Fed commentary exhibited this week led to a lower US$ and inverse strength in commodity and equity markets. This week the results have been anything but ordinary. The US$ gained strength, some commodities have rallied with the US$ (e.g. Oil) but precious metals have suffered. Meanwhile the Treasury markets have rallied and equity markets seem to have stalled.
The Fed’s commitment to a lenient stance is not a surprise. The following two stories are just a couple of the driving forces applying pressure to the economy and in turn the Fed…States scramble to close new budget gaps – WSJ
WSJ reports the patches used by states on their ailing budgets just months ago are now failing. Ohio lawmakers were expected late Thursday to vote on a compromise reached with Gov. Ted Strickland to avoid cutting education budgets an average of 10% on Jan. 1. In Arizona, lawmakers met in a special session Thursday — their fourth on the budget this year — to grapple with a new deficit. And in New York, Democratic Gov. David Paterson said Sunday he would postpone paying $750 million of state bills to avert a cash crunch. Many states eliminated expected deficits earlier this year with budget cuts, tax increases, short-term borrowing, accounting moves and planned gambling expansions. But despite a slight improvement in the U.S. economy, states are now finding those measures didn’t go far enough. Tax collections continue to trail projections in some states, and court rulings and political battles have blocked some gap-filling moves. Plus, some legislatures didn’t fully deal with the deficits, leaving the toughest decisions to governors… Only a few states now have cash-flow problems. But if revenues continue to fall below expectations, the list could grow, said Scott Pattison, executive director of the National Association of State Budget Officers.

…the US$’s strength as well as the strength in the Treasury bond market does however, provide some consternation. Apparently, other factors have overshadowed the Fed meeting this week and driven the direction of markets. Many attribute the strength of the US$ to troubles developing in Europe. The fears of a debt default in Greece have led some to believe the viability of the EU is in question. We believe this fear is unfounded and would instead direct your attention to the following story…

House narrowly passes $290 billion increase in debt limit –
WSJ reports the House approved a short-term $290 billion extension in the nation’s debt ceiling, delaying a decision until February about a larger increase in the borrowing cap. The vote comes less than a week after House Majority Leader Steny Hoyer (D., Md.) said he intended to seek a $1.8 trillion increase in the ceiling to support federal government borrowing through 2010. A decision was made to seek the more modest increase after it became clear the larger increase may have failed to win support in the Senate. The Senate must still take up the two-month increase, which it is expected to do next week.

…The decision to delay the “larger increase in the borrowing cap” in our opinion added fuel to a short covering rally already underway in the US$. I will note that the vote has only been delayed and will no doubt be passed in the not to distant future.

In short, year-long trends remain in place although severely tested this week. Seasonality would suggest equity market strength during the last two weeks of the year. Volatility as judged by the VIX index has remained subdued during this week’s shenanigans and would add credence to the idea of a resumption in seasonal trends.

More homes are poised to hit the market – LA Times
LA Times reports a supply of 1.7 million homes headed for sale because of foreclosure or delinquency looms over the nation’s housing market, which could dampen progress toward recovery should the Obama administration fail in its efforts to aid struggling homeowners, researchers said. A variety of measures to keep discounted bank-owned properties off the market — including moratoriums on foreclosures by major lenders and federal initiatives aimed at keeping people in their homes with mortgage payments they can afford — has helped increase a backlog of so-called shadow inventory 55% in the year ended Sept. 30, according to a report released Thursday by First American CoreLogic, a Santa Ana-based real estate research firm.

About Bret Rosenthal

Interpreting the news that moves markets. Principal of RCM, LLC, and founding partner of the Fortune's Favor Family of Funds
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