Market Commentary: Fed Extends Zero Interest Rate

market watch commentary

market watch commentaryOn Wednesday, the U.S. Federal Reserve announced that it expects to keep its near-zero rate policy in effect until the end of 2014, effectively extending previous guidance by 18 months. Faced with the prospect of three more years of near-zero money market rates, investors scrambled for yield, leading to a rally in U.S. Treasury securities, corporate bonds and other fixed-income instruments. Stocks also rallied on the news, with the S&P 500 closing Wednesday at a six-month high, before retreating later in the week.

By Dan Denbow, Assistant Vice President, Equity Portfolios

Because of the long-term inflationary implications of the Fed’s announcement, gold and commodities also rallied this week. Additionally, the expected long-term inflation rate implied by the difference in Treasury bonds and similar-maturity Treasury Inflation Protected Securities rose.

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USAA’s Dan Denbow talks about the signs of economic improvement, the Federal Reserve keeping interest rates low, corporate earnings and next week’s outlook. (Recorded Jan. 27, 2012)

The S&P 500 inched up 0.13% to close the week at 1,316. U.S. Treasury bonds rallied, with the yield on the 10-year dropping 0.13% to close at 1.89%.

Economic releases this week confirmed our view that Europe is in or nearing recession, and the U.S. economy will continue to muddle along its slow-growth path. The United Kingdom reported a contraction in gross domestic product of 0.2% for the fourth quarter. In addition, November new industrial orders for the eurozone declined by 1.4%.

On the domestic front, we saw mixed housing numbers, continued gradual improvement in the labor market and confirmation that fourth-quarter GDP accelerated. U.S. housing appears to us to be bouncing along the bottom. The index of pending home sales declined by 3.5% in December, which was a larger decline than expected by economists. The Federal Housing Finance Agency house price index showed signs of firming housing prices, with an increase of 1% in December. Home prices remain pressured, but recent data has shown positive momentum.

This week’s initial jobless claims number of 377,000, continues a multi-week string of sub-400,000 numbers confirming steady but slow improvement in the U.S. labor situation.

We were encouraged by positive manufacturing reports this week, which included a better-than-expected 3% December increase in durable goods orders, as well as meaningful improvements in regional federal reserve manufacturing indices in Chicago, Richmond and Kansas City.

Fourth-quarter U.S. gross domestic product grew by an inflation-adjusted 2.8%. Although this was slightly less than the 3% rate expected by the average economist, it represented an acceleration from the 1.8% posted in the third quarter. Note that economic growth is expected to decelerate this year, due to headwinds from a European recession and a strengthening dollar.

Fourth-quarter earnings announcements continue to roll in, with S&P 500 index members reporting 9% year-over-year average earnings per share growth. Apple Inc. was the standout this week, smashing expectations with fourth-quarter earnings more than doubling from a year ago. Other upside surprises were reported by Johnson & Johnson, Boeing Co., Lockheed Martin Corp., Caterpillar Inc. and DuPont Co. This was offset by weaker-than-expected results released by WellPoint Inc., Bristol-Myers Squibb Co., Ford Motor Co. and Chevron Corp. Also, enthusiasm was tempered by a 2012 business outlook provided by many companies which was lower than expected.

Next week, investors will continue to scrutinize earnings announcements. Major companies reporting include Exxon Mobil Corp., United Parcel Service Inc., Inc., Eli Lilly & Co., McGraw-Hill, Pfizer Inc., Allstate Corp., International Paper, Merck & Co., Kellogg Co. and MasterCard Inc. The major economic announcement will be Friday’s employment report from the Department of Labor. The consensus expectation is for a healthy increase of 150,000 jobs.

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As interest rates rise, existing bond prices fall. Foreign investing is subject to additional risks, such as currency fluctuations, market illiquidity, and political instability. Precious metals and minerals is a volatile asset class and is subject to additional risks, such as currency fluctuation, market liquidity, political instability and increased price volatility. It may be more volatile than other asset classes that diversify across many industries and companies.
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