Market Analysis

After continued heavy selling through the afternoon yesterday, bonds improved slightly this morning despite jobless claims numbers that came in better than expected.  Stocks are down despite the better economic news.  The concerns on everyone's mind is the Fed's QE2 program that is expected to be announced next Thursday.  Stock had definately priced in a very large QE2 announcement of approx $1 Trillion and are now retreating based on analysts scaling back what they think the Fed will announce.  Bonds began deteriorating prior to all the scale back discussion in reaction to the Fed's apparent desire to ramp inflation first and hope that demand follows later.  Then bonds deteriorated more as a consensus formed that there will be a scaled back Q2 because investors began to fear we will have an uncertain level of Fed purchases (what is now being discussed is $100 billion increments with the decision to continue purchasing to be made every approximate 6 weeks at the next Fed meeting).  Next year's Fed meetings will be January 25-26, March 15, April 26-27, June 21-22, August 9, September 20, November 1-2 and December 13.   In yesterday's commentary we discussed that the "fear" trade, not Fed action, is what drove 30 yr rates to current historic lows. As such with the market so distracted by QE2 we may be missing a developing story about improvement in the "fear" quotient regarding a Euro zone debt disaster.  I have not seen one mention of the European Union disbanding for months.  This is simply something to be cautious of from an interest rate perspective.  There may still be room for some minor improvement in rates once whatever is going to be announced for QE2 is announced next week, particularly if stocks correct after the meeting.   However, such a floating strategy is not without its risks as is any floating strategy. My personal opinion, which is just an opinion, is that the Fed will design their announcement more for the ears of equity investors than for bond investors and that even if they announce a scaled back program, they will find a way to do it in a manner that does not seriously spook the markets.  Also, I do not think it is completely out of the question that the Fed will announce a large $1 Trillion program.  The Fed is very aware that government stimulus which has been helping the economy tread above water will most likely be retracting next year and that there remains a greater risk at this juncture that the economy will reverse course, than there is that it will overheat.  To calm markets the Fed should find a way to incorporate a statement to the effect that they believe inflation will not grow at the pace some investors  fear and that their primary objective is to drive Treasury rates lower so that investors are forced to deploy capital elsewhere. 

In economic news today, Initial Jobless Claims for the week ended 10/23/10 came in at 434,000 which was below expectations for a 455,000 to 458,000 figure.  Continuing Claims for the week ended 10/16/10 came in at 4.356 million which was also lower than the 4.428 to 4.430 figure analysts were expected.