The Fed’s “2 for 1” Sale

All Hell broke loose yesterday when Fed Chief Alan Greenspan decided to replace the two most beautiful words ever whispered into a bond ghoul’s ear with a single term of far lesser endearment. The market, in search of an excuse to take profits for nine weeks anyway, held a “2 for 1” sale.

Such is what passes for thoughtful analysis on the Street sometimes. The market had made new highs on very light volume Monday, and then saw selling on much increased volume Tuesday and Wednesday. In the parlance of the technicians, these were “distribution days.” As the giddy momentum had driven the Bulls ever higher, this reversal of fortune became all but inevitable.

From a macro perspective, what significance do we ascribe to the substituting of the parental “patience” in the stead of a more exuberant (if we may use that word) “considerable period?” Warm Fuzzys aside, we believe these linguistic contortions signal three important changes in the Fed’s mind-set: 1) Incremental rate increases, formerly unthinkable (at least by us) in 2004, are now more likely by Summer; 2) The economy is showing resiliency, despite recent disappointing data series (Durable Goods, Home Sales, and Consumer Confidence); 3) An upside surprise may be in the offing from either 4thQ GDP or December employment data or both.

The tortured verbal gymnastics changes our prior expectation of no rate increases until after the ‘04 elections. In our opinion, higher rates in 2004 are now a very likely probability, starting with a ¼ point increase in June.

Given the horrific employment data we saw from December, the language change from the Fed may also be signaling that there is an imminent possibility of improvement in the Employment Situation. This would be a welcome – and long overdue – development. The Fed has access to data, which mere mortals (such as you or I) do not, and this early look may possibly be coloring their thought processes.

Nonetheless, we are staring at the kind of possible retracement, which made us so cautious last week. Look for short-term support around the 2000 level on the Nasdaq (then 1950), on the SPX, support is at 1076 then 1060. On the Dow, a move to 10,140 and then 9,900 would present good entry points, in our view.

There is an old cliché: for want of a nail, a kingdom was lost. It’s doubtful that for want of a word, a market will be lost.

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