Will the Fed Show Its Hand? - Ahead of Wall Street

Will the Fed Show Its Hand?

Wednesday, March 20, 2013

While Cyprus continues to provide some background noise, the focus today is on the Fed which concludes its two-day meeting this afternoon. In addition to the post-meeting statement, we will also be getting the economic forecasts of individual FOMC members and hear from Bernanke himself in the press conference. The issue at hand is the future of the Fed's $85 billion a month bond-purchase program which has done more than anything else in pushing stocks to the current all-time high levels. As such, it's more than just an academic exercise among economists.

Recent economic data has broadly been favorable. The housing momentum remains in place, as confirmed by Tuesday's strong February Housing Starts and Permits numbers. The labor market seems to be improving as well, with the weekly Jobless Claims numbers now under the 350K level, and even the factory sector seems to be showing signs of life again. In fact, the gains in household buying power as a result of the improving labor market and wealth effect from stock market and housing strength is helping offset the negative impact from higher taxes and gasoline prices. Last week's better than expected February Retail Sales data prompted many analysts to raise their estimates for GDP growth in the current and coming quarters. This improving GDP growth backdrop has put the spotlight firmly on the Fed's QE program.

The Fed is unlikely to announce any changes to the QE program today, but they will likely acknowledge the improving economic scene in the post-meeting statement as well as in the individual forecasts. We know from the minutes of the last two FOMC meetings that a strong group of the committee members are in favor of at least ending the open-ended nature of the current QE program, to give itself more flexibility to respond to changing economic conditions. We wouldn't see any evidence of those discussions in today's statement, but they will come out next month in this meeting's minutes.

For now, the core of QE supporters within the FOMC, comprised of Bernanke, Yellen, and Dudley, will hold their ground and continue with the program. Given the expected drag on economic growth from the budget sequester and other fiscal austerity measures, they will be looking for at least a couple of more quarters of steady economic growth before making changes to the program. But even then, they are unlikely to outright stop the program. They will most likely curtail the program at first, say from $85 billion a month to $40 billion a month, sometime in the back half of the year, before looking at ending it in the first half of 2014. All of this is contingent on the current favorable economic momentum continuing in the coming months and quarters. But as we saw in each of the last three years when the economy lost steam in the Spring/Summer months after positive starts earlier on, current expectations of the economy may not pan out.

Bernanke aside, we are getting ready for the start of the first quarter 2013 earnings season. The FedEx ( FDX ) report this morning doesn't inspire much confidence in what may be in store this earnings season, but expectations have fallen enough that we will likely see another good enough earnings season. It's not hard to draw that conclusion from the Adobe ( ADBE ) and Lennar ( LEN ) positive surprises this morning. Overall, total earnings for companies in the S&P 500 are expected to be down -3.9% from the same period last year, which will compare to the +2% final growth tally in the preceding quarter.

The expectation is that earnings growth bottoms in the current period, starts rebounding in the second quarter, and then growth accelerates in the back half of the year. This translates to a +6.7% earnings growth in 2013 and an impressive +11.7% growth next year. These positive earnings growth expectations reflect favorable outlook for the U.S. and global economy this year and next. The Fed appears to be skeptical of this optimistic view - why else would they continue with the enormous $85 billion a month bond purchase program. Perhaps we should be skeptical as well.

Sheraz Mian

Director of Research

ADOBE SYSTEMS (ADBE): Free Stock Analysis Report

FEDEX CORP (FDX): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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