Wall Street faces bleaker picture amid oil surge, hawkish Fed

Sunday, May 25, 2008
As Americans kick off vacation season, Wall Street is bracing for a darker outlook with surging oil prices likely to crimp an economic recovery and the Federal Reserve sounding increasingly hawkish.

The stock market, which had been on a strong run in April and early May, now looks increasingly fragile, analysts say.

The Dow Jones Industrial Average took a drubbing in the week to Friday, losing 3.9% to end at 12,479.63 ahead of the three-day US Memorial Day holiday weekend.

The Standard & Poor's 500 broad-market index slid 3.47% to 1,375.93 while the tech-led Nasdaq composite retreated 3.33% for the week to 2,444.67.

The market's tentative rally began to unravel in the past week as crude oil shot past 130 dollars a barrel for the first time ever and briefly hit 135 dollars.

To make matters worse, the markets got a clear message from the Fed that it would not lower interest rates further without a "significant" weakening of the US economic outlook.

That came in minutes from the April Federal Open Market Committee meeting, which indicated that the decision to lower the base rate to 2.0% was "a close call."

Deutsche Bank economist Joseph LaVorgna noted that the Fed's inability to keep stimulating gross domestic product (GDP) growth with rate cuts could mean deeper trouble as energy prices surge.

"The record high made in oil prices seriously complicates the economic outlook," he said.

"Higher energy costs raise the risk of higher headline inflation, lower GDP growth and a Fed which cannot further cut rates for fear of unhinging inflation expectations."

Ed Yardeni at Yardeni Research warned: "If oil prices continue to super-super spike, the outlook for both US and global economic growth would deteriorate."

"Stock prices aren't going up again until oil prices start coming down," he added.

The remaining hope for the markets, the prospect of rate cuts from the Fed, now seems increasingly remote, say analysts.

"The Fed has sent a clear message that it's not inclined to cut rates in June even if the economic picture continues to darken," said Avery Shenfeld, economist at CIBC World Markets.

"Such a darkening seems likely in the coming week's data, with ugly news on house prices, home sales, durable orders and personal income ... Add in soaring gasoline prices, and both equity markets and the dollar could be in for a tough week."

Despite the increasing gloom, market watchers say the stock market may be able to regain its footing, especially if there is some moderation in oil, which according to some is showing signs of a speculative bubble.

Al Goldman at Wachovia Securities said the market could see a rally this year if investors begin to put more cash to work.

"There is a ton of cash on the sidelines receiving a low rate of return," he said.

"Nothing motivates sidelined cash to buy stocks more than a rising stock market. Also, gloom is still pretty thick among investors, which creates the 'wall of worry' that bull markets classically climb. And every clear-thinking person knows that after a recession or economic hard times come economic recoveries."

Bonds edged higher over the past week. The yield on the 10-year Treasury bond fell to 3.831% from 3.850% a week earlier and that on the 30-year bond eased to 4.557% against 4.579%. Bond yields and prices move in opposite directions.

Data due in the holiday-shortened week include a report from the Conference Board on consumer confidence on Tuesday, and an update on first-quarter economic growth on Thursday. Friday, the government releases data on April income and spending, keys to economic activity looking forward. (AFP)