Forget the Sideshow: Just Resuscitate the Credit Markets

For the second week in a row, equities managed to post a positive gain despite heavy profit-taking at the end of the week. The S&P 500 gained 1.6% to close at 769. From the early March lows the market is up 20%.

The big news is the Federal Reserve’s announcement to institute a program to buy $1 trillion worth of mortgage-backed and Treasury securities in an effort to boost economic growth. The market for mortgage-backed securities has been frozen for months. The Feds attempt to thaw this market has been well received. The move is designed to lower mortgage rates so many homeowners (that are not under water and have jobs) can refinance. This should increase homeowners' cash flow and reduce foreclosures. In addition, this may induce prospective buyers to begin purchasing homes, thus bolstering the battered housing market.

Unfortunately while the Fed is doing its best to prop up the markets, save the banks and jump start the economy, Washington is too busy with its own sideshows. This one comes complete with a freak show of politicians berating AIG bonus recipients. While the outrage engendered by these bonuses is understandable, the grandstanding and legislative response is not productive.

If this proposed tax on bonuses received by TARP recipients is enacted, it will surely hurt the Fed's efforts to prop up the banking system. The bonuses are egregious but it is more important to get the economy jump started than to pursue a witch hunt. Stabilizing the banks should be our first and last priority. If we cannot stabilize the banks the economy will get much worse and the credit markets will freeze up further. Stabilizing the banks and greasing the gears of the credit markets should remain the government’s focus, not sideshows and witch hunts. Punishing these bonus recipients isn’t necessary because in the end the markets will extract its own retribution in the form of reduced pay or no job at all. Sooner or later these kings of finance will find that their industry has changed and the pickings are slim to none.

I anticipate the markets will be a little choppy but the rally will continue at a slow pace. If you are not in the stock market, I highly recommend that you start dollar cost averaging back in.

Last Week in Review

Last week in every market segment was down including energy, materials and utilities. Overall, it was a tough week with the S&P500 down 3.1%, Nasdaq fell 2% and the Dow Jones Industrial declined 3.8%. Year-to-date the S&P500 is now down 9.3%. Small caps continue to outperform large (less negative) and growth is trouncing value investing. Market jitters continue and the bears are winning.
Oil troubles continue with prices rising to new highs. Increasing energy prices have stoked inflation fears. The numbers of speculators in the commodity markets is growing rapidly only adding to the feeding frenzy. In addition, escalating tensions between Israel and Iran is adding instability to an already rocky oil market. The scuttlebutt is that Israel will bomb Iran with assistance from the U.S. in the next six months. Oil prices will soar to over $200 a barrel if Iran is attacked. Baring an attack, the energy markets look very frothy and should retrench from these lofty levels.
Problems in the financial sector persist. Banks have only written off one-third of their bad investments and the housing market is rapidly disintegrating. These problems will not be fixed overnight. Until the housing market begins to recover the economy and markets will stay in turmoil.
Inflationary forces continue in the developed and developing world is reaching the choking point. Many economists feel inflation is not that bad because it has not spread to workers. Rising unemployment is keeping wages down. So in economist-speak inflation is not so bad.
In the real world the problem is that the collapsing housing market in conjunction with rising food, energy and healthcare costs have taken the consumer out of the market. I know I write this all the time but two thirds of our Gross Domestic Product (GDP) is generated by consumer spending. Consumers aren’t spending (look at the recent performance of retailers and automobile manufacturers). Consumer lead recessions (vs. business lead recessions) are always deeper and take longer to recover. It takes more time to build up consumer sentiment and get consumers spending again. This is not going to be an easy and quick V-shaped recovery. It will probably resemble a very wobbly wide W-shape.
The Fed is talking hard ball and many of its members want to raise the Fed Funds Rate when they meet. It will be difficult for them to raise rates any time soon because it would bring this fragile economy to a screeching halt. Instead, they will have to keep rates where they are and if things get worse they may have to lower rates again.
In the short run, the market will remain choppy with equities swinging significantly down on bad news and moderately up on good news.
I will be in Chicago this week at the Morningstar Conference. I hope to meet with numerous portfolio managers of mutual funds. I will be reporting back my findings and interviews.

The Fed at Work: A Play-by-Play Commentary

Relying on both conventional and unconventional means, the Federal Reserve (Fed) has been attempting to break the credit crisis’ stranglehold on the economy. It has been extraordinary to watch the Fed take actions that have not been used since the Great Depression, and a few actions that have never been used.
The Fed needs to be aggressive because the current liquidity crunch in the credit and mortgage markets is creating a negative feedback loop between the financial markets and the U.S. economy. The strain in the credit markets is putting pressure on the broader economy, leading to further weakness in the housing market, which then creates further dislocations in the credit markets, etc., etc., etc. Additional aggressive policy action by the Fed will be essential to break this self actuating spiral.
Since September the Fed has slashed its overnight lending target to 2.25% from 5.25%. It has also injected $200 billion into the credit markets by opening the Fed’s borrowing window to non-banks (such as investment banks), and has loosened collateral standards for these short term loans and now accepts lower rated asset-backed securities. In other words, an institution can pledge riskier bonds as collateral and receive Treasuries from the Fed. The Treasuries can easily be sold to generate the cash needed by the firm to meet its obligations. These loans are short term and will have to be paid back but in the mean time liquidity has been improved which will prop the credit markets up and keep the asset-backed bonds and lower credit quality bonds from falling further.
The Federal Reserve has now committed approximately half of the Fed’s portfolio to the fight and has pledged to commit more if necessary. Essentially, the Fed is using its own balance sheet as a tool to inject funds into the market right where it needs it the most. It is this type of creative aggressive action that is requisite if the Fed hopes to break the negative spiral between the economy and the credit markets.
The Fed also stepped in to ensure that Bear Stearns did not go under. Bear Stearns found itself in trouble because Wall Street began to question whether the investment bank had the necessary capital to back all its trades and bets. The firm was the highest levered investment bank (least assets to greatest debt) on the Street by a significant amount. Bear Stearns was not a very popular investment bank with its compatriots due to its aggressive brass-knuckle tactics. The combination of its bad rap and the high leverage ultimately set the stage for its demise. The firm began to go under as investors pulled their money on rumors of illiquidity and lenders called their loans and refused to extend additional credit. It was a classic run on a bank, the kind we saw Jimmy Stewart stave off in “It’s a Wonderful Life.” It was the old one-two punch. I feel no sympathy for the executives at Bear Stearns. If you swim with sharks, you do business with sharks, you act like a shark, then you are a shark and may be attacked, killed and eaten by other sharks.
The Fed stepped in and helped negotiate the purchase of Bear Stearn’s by JPMorgan for $1.2 billion in stock. In addition, JPMorgan will also absorb any losses on the first billion dollars of $30 billion of Bear’s riskiest assets. Those assets will be managed independently by BlackRock. The Federal Reserve Bank of New York is guaranteeing the remaining $29 billion, and in return, will reap any gains from that portfolio.
Why bail out Bear Stearns? After years of never allowing any of our financial institutions to fail, these banks have become so interwoven and enormous that nobody can be allowed to sink beneath the waves. Otherwise, a tsunami would swamp the hedge funds, banks and other brokerage firms that remain afloat. If Bear Stearns failed, for example, it would result in a wholesale dumping of mortgage securities and other assets onto a market that is frozen and where buyers are in hiding. This fire sale would force surviving institutions carrying the same types of securities on their books to mark down their positions, generating more margin calls and creating more failures, further hurting the economy and the housing market (the spiral). This bailout is less about saving Bear Stearns and more about shoring up the financial markets, housing markets and the economy.
On the flip side, this deal does not pass the sniff test. Why hasn’t there been another bidder? I find it difficult to believe that no one else was interested. It couldn’t have been that unstable because if the situation were so precarious, why wouldn’t shareholder ownership position be completely wiped out. Instead, a week later the bid is raised from $2 to $10 a share (a $1 billion increase in value). Is JPMorgan manipulating the situation to protect its $91.7 trillion dollar derivative exposure (per Office of Comptroller of the Currency September 2007 reported data) which is backed by only $123 billion of equity? How much of this counter party exposure did JPMorgan have with Bear Stearns? I can only surmise that JPMorgan made a sweet heart deal with the Fed and other governmental agencies. The deal would require JPMorgan to commit whatever resources would be necessary to prop up and acquire Bear Stearns. In return the Fed would not allow other suitors to bid up the price and they would not disclose JPMorgan’s full exposure to Bear Stearns. In essence, the Fed propped up both JPMorgan and Bear Stearns. One bank ate another and won. The game goes on.
The government has also reduced capital holding requirements for Fannie Mae and Freddie Mac from 30% to 20%. This frees up more money that Freddie Mae and Freddie Mac can use to purchase mortgages, thereby shoring up the mortgage-backed securities market. This increase in funds will help add liquidity and hopefully begin to break the gridlock that is crippling the credit markets. The regulatory body that oversees Fannie Mae and Freddie Mac has said they would lower the capital requirement even more if needed.
Congress has begun to do its part to break the spiral. As part of an economic stimulus package enacted last month, the cap on standard mortgages was temporarily increased from $417,000 to $729,750 in high-cost markets through the end of the year. Standard mortgages usually have lower interest rates than jumbos because they can be purchased or guaranteed by Fannie Mae or Freddie Mac. This is a great idea and could have made lower cost mortgages available in some of the most hard-pressed expensive housing markets. Unfortunately, this has just created an intermediate tier to the mortgage market. These tweener-loans are less expensive then the jumbo mortgages but the interest rates are not as low as a standard mortgage under $417,000. The loan originators are pricing the loans to reflect the additional risk they are taking with these tweener-loans because Freddie Man and Fannie Mae could decide to not purchase or guarantee them. So this part of the stimulus plan has been a bust.
Despite the efforts of the Fed, credit markets are not functioning properly. Sizable losses on subprime loans have lowered the capital base of many financial institutions. The situation is exacerbated by a financial system that has, over a period of years, become intertwined in a spaghetti-like fashion through the spread of complex financial products (CDOs, CLOs, CDSs, and the like). This complexity makes it difficult to clearly understand what assets may be at risk, how big those risks may be, and also who is at risk. This uncertainty has led financial institutions to retrench, which in turn makes credit (loans) more expensive and less available—even while the Fed tries to make credit less expensive and more available. If there are any more major disruptions in the credit, the Fed will have a very difficult time restoring equilibrium. According to Bill Gross at Pimco, what Washington really needs to do is get off its “high moral-hazard horse and move(s) to support housing prices… Authorities must act quickly, with a shot of adrenalin straight to the heart of the problem: housing prices…The decline needs to be stopped quickly in order to avert additional crises.”

The Math: Economy Less Consumer Equals Recession

Without a doubt, investors will remember 2007 as the year that the housing market collapsed and triggered a credit crunch. The earnings of just about any company that was involved in homebuilding or lending were crushed, and resulting economic worries triggered stock declines for many consumer goods companies. Simultaneously, U.S. exports boomed, reaching an all-time high of 12.1% of GDP. Not surprisingly, companies with significant foreign-based earnings did well. Overseas stocks also delivered great returns, and as these economies continued to grow so did their demand for energy and raw materials commodities from China and other high-growth developing countries.
The last four months have been difficult for stocks as prices have declined substantially from their highs in October 2007. The markets have broken through many technical support levels -- this is true for every major index (Dow Jones, Russell, Nasdaq and S&P), which means that technical damage has been done.
The good news is that the Federal Reserve has finally woken up to the severity of the situation and is working diligently to respond to escalating economic concerns. On January 22, 2008, the Fed unexpectedly cut the fed funds rate by 75 basis points (0.75%) from 4.25% to 3.50% in advance of its policy meeting. The Fed has not cut rates in one stroke by such a large amount since 1982. In making the cut, the Fed cited the “weakening of the economic outlook and increasing downside risks to growth.” This move was desperately needed to ensure market stability and sooth investor fears. Sinc then, the Fed has continued to cut rates and has stated its willingness to cut rates further to shore up the markets.
It appears that the combined impact of the housing implosion and the fallout from the structured finance debacle has pushed the U.S. into recession - or at least whole sectors of the economy are now in recession. How protracted the economic weakness will be and what its full impact on the markets are the new questions to be answered.
The key to an economic turnaround is consumer spending because it accounts for 70% of our economy (Gross Domestic Product—GDP). The falling housing market and the resulting tightening of mortgage lending have hit consumers hard, causing them to spend significantly less. Consumers who are more and more worried about the overall economy have triggered stock declines for many consumer goods companies.
A volatile stock market does not help consumer sentiment either. When you add rising unemployment to the mix, it is obvious that the U.S. consumer isn’t going to go on a spending spree anytime soon. It will be tough to entice the consumer to start spending when it is difficult to borrow, and many are already heavily in debt. Until credit markets are repaired, the consumer won’t start spending enough to cause a recovery, and businesses will curtail spending. If consumers and businesses aren’t spending, that only leaves the federal government, a scary thought. Even the proposed fiscal stimulus plan by the President won’t be enough to turn the tide. When credit becomes this tight, a recession is almost inevitable.
How did credit get so tight? Why are funds more scarce and underwriting criteria toughening? It all started with the mortgage-backed securities and how they are packaged and sold through our unregulated shadow banking system.

The Economic News

I regularly attempt to explain the current state of the economy, the Federal Reserve’s policy stance, and other news items that could impact the markets. It is difficult to present the general state of the economy in just a few paragraphs, so I was thrilled when I discovered this scorecard designed by JPMorgan. I’ll try to regularly include it in my future newsletters. If the chart seems unclear just click on it to get a larger clearer view.

Many economists believe that we are close to full employment (5% or less unemployment is considered full employment by economists and the Fed). These gurus fear that full employment could lead to rising wages which could then cause inflation. The Federal Reserve is focused on the core rate of inflation (inflation less the volatile food and energy segments). Inflation is currently at the high end of the Fed’s defined range of acceptable. So the Fed’s board members want the core inflation rate to fall but don’t want to raise interest rates again to achieve it. The Fed wants the market to adjust itself.

When Bernanke became Federal Reserve Chairman he stated that he wanted to communicate the Fed’s intentions more clearly to investors. The unintentional result has been the inversion of the yield curve (short term interest rates are higher than long term rates). In order to get long term interest rates up, the Fed has begun to abandon its policy of clear communication and transparency. It is instead refusing to send a clear message. The Fed recently changed its stance to neutral (instead of signaling its intention by stating a bias towards raising or lowering rates) but it is all posturing. The most recent Fed minutes from its last meeting are meandering and unclear. Consider, for instance, this excerpt from the minutes:

…the prevailing level of inflation remained uncomfortably high, and the latest information cast some doubt on whether core inflation was on the expected downward path. Most participants continued to expect that core inflation would slow gradually, but the recent readings on inflation and productivity growth, along with higher energy prices, had increased the odds that inflation would fail to moderate as expected; that risk remained the Committee’s predominant concern.

The Fed's mixed reactions regarding inflation are unsettling to many analysts and economists. It is all part of an elaborate game of chicken as the Fed desperately tries to balance the need to moderate inflation with keeping the economy growing. If the Fed has to raise short term rates to check inflation it might also destabilize the financial markets. If the Fed states a bias towards lowering short term rates, it could cause the markets to grow too quickly the old boom followed by bust pattern). The Fed hopes to avoid these scenarios by convincing the market to raise long term rates which should help moderate full employment and wages and hence cool the core inflation rate. It will be interesting to see who blinks first, the markets or the Fed.

The Financial Pragmatist

Libby Mihalka

Analysis of Bernanke's Inflation Outlook

Here is the transcript from an interview from last nights Nightly Business Report on PBS.
This discussion is interesting because it shows the current debate concerning the strength and direction of the markets. Battipaglia's outlook is very pessimistic and he currently has over 30% of his client's allocation in cash (50% of his client's 60% equity allocation is in cash plus a percent of the bond portfolio). His firm is really expecting the markets to correct substantially. Market timing, to this extent, leads to under performmance.

Enjoy
The Financial Pragmatist
Libby Mihalka

Joe Battipaglia of Ryan Beck & Brian Wesbury of First Trust Advisors
Analyze Fed. Chairman Bernanke's Inflation Outlook

Wednesday, March 28, 2007

SUSIE GHARIB: More analysis now on Bernanke's testimony today and market reaction. Joining us, Joe Battipaglia, chief investment officer for Ryan Beck and Brian Wesbury, chief economist at First Trust Advisors. Brian, Joe, thanks for joining us.

BRIAN WESBURY, CHIEF ECONOMIST, FIRST TRUST ADVISORS: Good to be with you.
JOE BATTIPAGLIA, CHIEF INVESTMENT OFFICER, RYAN BECK: Good to be with you.

GHARIB: Brian, let me begin with you. Do you agree with Ben Bernanke's assessment of the economy that inflation is the risk of not weaker growth?

WESBURY: I do. I think that we've seen a slowdown in housing. We've seen what I would call an inventory correction, which is caused industrial production and durable goods orders to fall over the last few months, slow down the economy a little bit in the last few months. But the real risk to the economy in the next six, 12, 18 months is inflation.

GHARIB: Joe, Wall Street seems to have thought that that slowdown in housing, now that the economy is really slowing, evidenced by all the sell- offs we've had this week. What's your analysis of what Bernanke said?

BATTIPAGLIA: The street wants it both ways. They want a soft economy and ultimately rate cuts and what a good situation that is for stocks. My worry, actually, is the economy. The Fed has never engineered a soft landing. The data is more troubling than they are letting on too. They've already changed their language to that effect and I think it's a credit- driven problem in that consumers are tapped out, and so this may well be a consumer-led slowdown with the potential for a recession at 50 percent. The market certainly not looking for that and that's what's going to be more troublesome in the next several months. Add to that the persistence in inflation. You've got a very dangerous mix here.

GHARIB: But Brian, the message from Bernanke seems to be that the next move that the Fed makes on interest rates, when it does decide to move, that it will be up. It will be a rate hike not a rate cut. Is that your take on what Bernanke said today?

WESBURY: Well, I would argue that what he really said is that he wanted more flexibility. In fact, that's almost a direct quote. And that's why they sort of pulled back. But more importantly, one of the things he wanted to do was have the market stop being telegraphed the Fed's next move. He wants the market to be a little more uncertain about what the Fed might do. And one of the reasons that he wants that to happen is he wants long-term interest rates to go up. Remember, Alan Greenspan called the low, long-term interest rate the conundrum. Ben Bernanke has theorized that maybe it's happening because of a global savings glut or something like that. He's trying to get long-term rates up and one of the ways to do that is to increase uncertainty in the markets and I think that's one of the things he's trying to do today.

GHARIB: He did say that. He said he's going to give less guidance on interest rate moves. Joe, what does that mean for the market? Is it going to be much more volatile going forward?

BATTIPAGLIA: Oh, I would say so because if he is data centric here and looking for the next bit of news on the economy and on inflation, then he's no better off than the rest of us are in trying to figure out what happens next and right now his credibility is on the line because on the one hand, he wanted to be more transparent. If you want to be more ambiguous, that's not transparent. And the other is he wanted inflation below 2 percent but he doesn't have that. He's at 2.7 or 2.3, depending on how you measure it. Credibility at the Fed is at risk, Ambiguity is a problem and the economy itself has got very weak signals coming on, six months of slowdown in durable goods and a consumer that is gliding down the path of less houses being bought, less cars being bought, retail sales slowing down.

GHARIB: Brian, Bernanke also said that he didn't see any evidence that this whole sub-prime mess is affecting the broader economy. Is that really the case or was he just trying to reassure everyone?

WESBURY: No, I think he's correct about that. I think the sub-prime issue is a problem, but it's not a problem that will have a contagion effect that drags the entire economy along. And I think this is an important point. One of the reasons that we're in the mess with mortgages and housing that we're in is because the Federal Reserve lowered interest rates to 1 percent back in 2003. You can't drive interest rates down that low without causing people, some people to make decisions that they can't live with if interest rate goes back to normal and that's exactly what's happened. But interest rates today aren't high. And that's why I won't go as far as Joe does. Interest rates today, in fact, are still very low, especially given the inflation rates that we have seen. And, therefore, I don't think we're on the front edge of a recession or a big consumer--

BATTIPAGLIA: Here's the tip of the spear on this. I need to interrupt because most people are saying the same thing, except that the biggest asset that people own are their homes. Those prices are only starting to fall and they fall by 5, 10 or 15 percent or more depending on the market. And interest rates on the teaser side are going to be adjusted up, even with the low rates that Brian speaks to, they're going to double or triple from here and they can't refinance because their home values --

GHARIB: Joe, let me jump in. We just have a few seconds. Real quickly Joe, are you changing your investment strategy because of your views on what Bernanke said and the economy?

BATTIPAGLIA: We came into this with 60 percent equities 40 percent in defense of asset classes. In our equity programs we're at 50 percent cash looking for future opportunities. So we re definitely defensive and we've lowered our S&P target for the year down to 1430. So we're essentially looking for a flat year.

GHARIB: We're going to have to leave it there. Gentlemen, thank you very much, I appreciate your thoughts.

BATTIPAGLIA: You're welcome.

GHARIB: My guests tonight: Joe Battipaglia, chief investment officer for Ryan Beck and Brian Wesbury, chief economist at First Trust Advisors.

Rise in Producer Price Index Shows Inflation Not in Check

Today, the Federal Reserve received mixed signals regarding inflation. Last week’s great news that inflation seemed under control, with no increase in November’s consumer price index, was obliterated by today’s report on November’s producer price index. This is the price that businesses charge each other for oil, produce, and metals.

The bad news, wholesale prices shot up 2% in November. The producer price index has not increased that much in a month for over 32 years. These latest figures will make it difficult for the Fed to change its stance from a defensive posture of raising interest rates to an expansive posture of lowering rates anytime soon.

It is unusual to see such a high rise in producer price index not reflected in the consumer price index. It means that companies absorbed the rising cost of production and did not pass it on to consumers in the form of higher prices. If the producer price index keeps climbing at such a high rate, these increases will inevitably have to be passed on to consumers. Inflation!

The economic fog is thickening and there are some strong cross currents. It is difficult to predict which way the economy will go in 2007. Fasten your seat belt and turn on the fog lights.

Consumer Prices, Inflation, Unemployment, and Corporate Profits

Great News! U.S. consumer prices were flat in November. Most economists were expecting a small rise of 0.2% rise for the month. This could allay inflationary fears at the Federal Reserve. The market will now expect the Fed to focus on lowering interest rates towards the middle of 2007 and stop thinking about further rate hikes. Stocks and bonds will trade up on this news.

In other good news, the Labor Department reported that the number of Americans filing for unemployment benefits dropped for a second week. This will begin to allay another fear investors have had that the economy might cool quickly. A long gradual landing of this bull market is what investors are hoping for in 2007.

Robust quarterly profit reports keep rolling in, with Costco, Honeywell and Citigroup all reporting good news.

Consumer spending is now the worry. The economy is a three legged stool with spending by the government, businesses and the consumer. Government and Business spending is expected to be moderate. It is the consumer that has been driving economic growth. Will Americans decrease their spending as housing prices contract? Will a decrease in wealth (caused by falling housing prices) translate into consumption? Many economists and investors have been waiting for most of 2006 for consumers to feel this falling wealth effect and moderate their spending. It appears that the low unemployment rate could be bolstering consumer confidence because consumer spending has not abated. If the consumer stops shopping, then this bull market is probably over.

Federal Reserve Leaves Interest Rate Unchanged

The Federal Reserve held tight leaving its key overnight interest rate at 5.25%. The Fed gave no hint whether it would be changing interest rates anytime soon. Many economists expected the Fed to allude when it might start cutting rates. Instead, the Fed held open the possibility that it might increase rates if inflation does not moderate. It also expressed concern regarding the slowing housing market. The Fed described the housing slowdown as "substantial". This is stronger language than the Fed has used before.

The Fed is talking tough to keep a lid on inflation in hopes that it will not have to act tough and raise rates again. The stock market pulled back today (Tuesday December 12th), finishing slightly lower as investors grappled with the Fed's economic assessment and worries about accelerating inflation.

Friday’s release of November’s consumer price data will give us an indication of the Fed’s success at taming inflation. The Bloomberg poll predicts a 0.2 % increase, after food and energy items are removed. The increase for October was 0.1 %.

The Federal Reserve Meeting, Inflation and Interest Rate Changes

The big news this week is the Federal Reserve's scheduled meeting tomorrow (Tuesday). However, the Fed is not expected to make any big moves and should keep interest rates steady at 5.25%. Despite some of the recent gloomy news, the economy has been performing well. Why? The Service Sector of the U.S. economy is chugging along on all cylinders; it’s the manufacturing part of the economy that is causing some economists to worry. That’s the sector that manufactures things and builds homes, which appears to be on the brink of recession while the Service Sector continues to surge. The simple truth is that the Manufacturing Sector represents only one-fifth of the economy, and is not as important as it used to be. The Service Sector is the motor that now drives our economy. So what will the Fed focus on? It will look intently for any signs of inflation in the Service Sector. The members of the Federal Reserve will scrutinize all the employment and labor cost statistics. They will be worried about the low unemployment figures and the recent increase in wages. The Fed will remain cautious on inflation but they won’t take action. Do not expect a rate cut anytime in the near future.