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Federal Reserve Hints

Waiting For Data

Federal Reserve governors, speaking on Monday signaled that the central bank is well aware of the fact that any more rate hikes could be one too many.

Janet Yellen, President of the San Francisco Fed, told an audience on Monday that the central bank is "at a delicate point for policy, when we are close to the end of the road," but was careful to note that she "was not signaling what the Fed would do Aug. 8," according to MarketWatch.com.

Marketwatch added: "Yellen's comments followed comments earlier in the day at an event in Kentucky by William Poole, the president of the St. Louis Federal Reserve Bank, at which Poole said he was still undecided on the Fed's August rate decision, putting the chances of an August rate hike at 50-50."

Both Yellen, who votes at the FOMC, and Poole, who is a non voting member, referred to upcoming data, a lot of which will come later this morning (see calendar above), and Friday's employment report, as important in the Fed's decision making process.

Yellen went out of her way to state the Fed's current head scratching mode. According to MarketWatch: 'During the speech, Yellen said that the current federal funds rate of 5.25% "lies in the vicinity that is roughly appropriate for the Fed to attain its key objectives over the medium term." "Now we're too the point where it is tricky. We're coming close to the end of the road, but exactly where is the end of the road? It is very hard to say," Yellen said.'

Both Yellen and Poole noted that recent data points to slowing economic growth, and predicted that the economy was likely to slow further in the coming months, something that they thought should slow inflationary pressures.

No wire service reports noted any remarks with regard to the effect of the energy markets on upcoming Fed policy, although that has been a theme of Fed Chairman Bernanke's speeches, and Congressional testimony.

The Fed's recent Beige Book suggested a spotty economy with significant differences in performance between regions, as well as within different sectors in the economy.

One of the most important factors that the Fed looks at is wage related inflation. The Beige book noted that highly skilled workers were claiming premium wages, but did not suggest that overall wage inflation was a problem at this point.

The areas of significant strength in the report were manufacturing and commercial real estate, while residential real estate continued to weaken.

In our review, last week, of the Fed's Beige Book, we noted that demand for semiconductors was showing signs of increasing.

In the past, this kind of mention in the Beige Book has coincided with strength in the chip stocks, which are very oversold.

Over the last few days, we've noticed that the Philadelphia Semiconductor Index (SOX) has stopped falling.

Yellen stressed caution in her remark, noting: ""The need to incorporate lags between policy actions and effects on the economy is a key issue. We don't know what the lags are with precision, but we still need to do the best we can to take them into account."

Mr. Poole and Ms. Yellen, who both emphasized the importance of fresh data to the Fed, will get their fill on Tuesday, as eight reports, focusing on retail sales, as well as manufacturing activity will be released throughout the day.

The action in the bond and currency markets is likely to be the biggest hint as to what happens in the stock market.

Conclusion

Stocks continue to move sideways, as the transition between strong economic growth and the next step, a soft landing or a hard landing takes shape.

The Federal Reserve is relaying a message of caution to the markets.

With so much economic data out this week, we would expect the market to make a move, especially by Friday, when the employment report is due.

There are some major intangibles at work, though. The situation in the Middle East, and the Chinese economy, in our view, are the two major outside influences which may influence the Fed's decisions at its August meeting.

Wars tend to be inflationary. And China's explosive growth is starting to show signs of inflation, or the Chinese central bank would not have drained bank reserves twice in the last four months.

Just something to think about for those who think that a pause by the Fed is a slam dunk.