It's hard to imagine a set of news that could collectively do more damage to so many markets than this week's reports. The Fed appears to be losing its taste for quantitative easing, the economy is looking less robust than hoped, and now even the corporate news has turned negative. The 10-year Treasury surged to 2.86% and stocks fell sharply for most of the week; on Thursday the Dow fell more than 200 points.
The Fed's San Francisco District issued a paper this week that suggested QE2 added just over 0.1% to GDP growth, hardly the kind of return one would expect from a relatively risky policy. Some of the Fed governors must have been reading the paper as even the more dovish governors seem to be entertaining the possibility of reducing bond purchases as early as September. The recent soft economic data doesn't seem to have scared any of the governors who have been speaking recently. To be fair, the Fed claims to be primarily interested in just employment data and inflation. With initial unemployment claims hitting a recovery low and year-over-year inflation picking up again (both announced this week), one couldn't be blamed for thinking the end of bond purchases remains clearly in sight. About all that stands in the way of a September tapering program is the August employment report. My guess (I am stressing the word "guess" at this point) is that it might be bad enough to give the Fed pause. However, that just delays the Fed's inevitable withdrawal from the bond market and higher interest rates.
Most of the economic news wasn't great: retail sales missed the mark, year over year inflation showed some growth again and industrial production went flat. Housing starts bounced some, but not as much as expected. Again, none of the data was a disaster; it just means more slow and unsatisfying growth. There were some positives: initial unemployment claims struck a new recovery low, Europe managed to pick itself back off the mat and homebuilder sentiment struck a new recovery high.
