The S&P 500 has followed a pattern of ups and down ever since confusion over the Fed’s intentions became an issue in May. This week the Fed gets another chance to communicate more clearly. The Federal Open Market Committee (FOMC) meets on Tuesday and Wednesday, but importantly, this meeting will be followed by a press conference, providing Chairman Bernanke an opportunity to clarify the Fed’s thinking, and settle financial markets in the process. Whether he succeeds remains to be seen. Either way, expect no change in policy. The recent economic data has been better than it was earlier in the spring, but almost certainly has not been strong enough to convince the Fed to change. This also likely means the July meeting is out as well for any change, since any economic improvement will not have persisted for long enough to be convincingly sustainable. Bernanke is likely to re-emphasize that the path of policy is data dependent. He is also likely to point out that even after any tapering of quantitative easing begins, monetary policy will still be quite accommodative, and interest rates are likely to remain near zero for a considerably longer time. It would be great if he went so far as to point out that the gradual removal of Fed accommodation is exactly what we should all want.

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After suffering through two straight weeks of losses, stocks staged a strong rebound on Thursday and Friday to squeeze out a gain of 0.8 percent last week. Confusion over the Fed’s intentions and mixed economic data had driven the S&P 500 lower by 3.6 percent from its closing high of 1669 on May 21, to its recent closing low of 1609 on June 5. The move higher on Thursday and Friday earned back a lot of that decline with a combined gain of 2.1 percent. If the recent pullback has run its course, which certainly remains to be seen, it will have looked quite similar to the two previous pullbacks we have experienced so far this year. The first came between February 19-25, in response to the release of minutes from the Fed’s January meeting. It resulted in a 2.8 percent decline. The second came between April 11-18, and came after some unexpectedly weak economic data and the release of more Fed minutes. It resulted in a decline of 3.2 percent. Beyond the similar extent of these three declines, another common element is the unmistakable influence of the Fed in both triggering them, and resolving them. Each was triggered to various extents by rising fear of the Fed pulling back on quantitative easing sooner than expected. And each concluded as those fears subsided, either in response to public statements by the Fed, or in response to the release of economic data that will have a strong bearing on the Fed’s thinking.

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Today’s numbers were clearly a welcome surprise.  Job growth is still a bit weaker than desired at this stage but the fact that it is holding up as well as it is, despite the exceptionally strong headwinds of higher taxes and sharp government spending cuts, is a testament to the economy’s much improved underlying fundamentals.

Demand ultimately drives the economy and the improvements we’ve recently seen in the consumer sector should eventually pull other sectors of the economy, such as manufacturing and employment growth, up to healthier rates of expansion. Consumer spending has been improving in recent weeks and was particularly strong over the Memorial Day weekend; the recent rebound in consumer sentiment also suggests that these improvements could build momentum going forward.


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