Macro economic events still dominate

Fed on tap

Investors have been reeling from one piece of bad economic news after another. That’s why a couple of releases that didn’t surprise to the downside was enough to capture the attention of the markets, helping the Dow Jones Industrials and the S&P 500 Index, which have been starved for good news, squeak out gains and snap a six-week losing streak.

First, retail sales in May managed to barely exceed reduced expectations, strongly hinting that debt- and recession-weary consumers are not heading back into their post-Lehman Brothers’ caves.

Second, weekly jobless claims remain elevated, but a drop last week is a strong indication that economic activity isn’t grinding to a halt. A rebound in the Leading Index is also suggesting that the slow and uneven expansion is not petering out.

But action across the Atlantic has not gone unnoticed, as another downgrade of Greece by Standard & Poor’s and fears that there will be an eventual default of some kind has had a mixed impact on the credit markets.

The flight to safety continues, with the yield on the ten-year benchmark Treasury back below 3%, while the yield on the two-year note fell under 40 bp, a record low!

The euro has also come under pressure amid fears that the problems in Greece could affect other wobbly nations on the continent. And CDSs (insurance on debt) on financials have risen. Defaults beyond Greece could also do damage to banks and institutions in the USA that hold debt instruments from those countries.

Interestingly, however, measures of risk in the credit markets – three-month LIBOR and the two-year interest rate swap spread – have barely reacted to the latest crisis, seemingly suggesting a “business as usual attitude” among the players in the credit markets.

We did finally see a fairly noticeable uptick in the swap spread this week, but we’re far off the post-Lehman levels and well below what we saw last year before the first bailout of Greece (see chart below).



Moreover, the LIBOR is holding just above a record low.

Fed's up
Next week brings us to the latest in existing home sales, but the two-day Fed meeting, which concludes on Wednesday and the second-ever press conference from Fed Chairman Ben Bernanke’s will get heavy play.

It’s always a bit dicey trying to outguess the Fed, but I suspect that policymakers will acknowledge that the recovery has slowed, job growth remains painfully slow, and it will reiterate that the recent uptick in inflation is transitory.

There have been no hints that the Fed will extend QE2. Rates won’t change, and it seems unlikely that the Fed will come close to hinting at any rate hike.