Fed's Dilemma: Markets Want Both Growth and Stimulus

Fed Chairman Ben Bernanke's remarks to Congress this week satisfied neither those who believe the economy can stand on its own nor those who want the central bank to continue playing a role in the markets.

Pablo Martinez Monsivais / ASSOCIATED PRESS

A day after most risky assets in the stocks and commodities areas posted losses on Bernanke's remarks, stocks gained enough Thursday to make the Bernanke appearance an even draw.

But behind the trading, Wall Street seemed to want to have its economic recovery cake while it eats more monetary easing, too.

Bernanke delivered what historically had been known as his Humphrey Hawkins remarks to the Senate and indicated that the recent turn in data — manufacturing, housing and employment to name three — gave him confidence that the recovery, while uneven, was a bit better than he had anticipated.

The market interpretation, then, was that the chairman would be advocating no more of the monetary easing that has helped boost risk asset prices. At one point Wednesday, the Dow had fallen more than 125 points before erasing more than half its losses by the close.

The speech interrupted a sharp 2012 rally in stocks, while also triggering an abrupt sell-off in gold and other inflation-sensitive commodities. More broadly, the moves provided indication that the financial markets are still highly sensitive to the Fed's maneuvering.

"The fact that this reaction was mostly negative points to a surprising fragility in the prices of risk assets," Julian Jessop, chief global economist at Capital Economics in London, said in a note.

"In particular, the equity markets appeared to be disappointed that the signs of a stronger economic recovery — previously regarded, of course, as a positive — mean that Bernanke felt no need to signal another round of quantitative easing," Jessop added. "This makes one wonder whether investors would have been happier if the Fed chairman had talked down the economy and suggested that further monetary stimulus will be required."

Such reaction could indicate a market not facing reality, he said.

"The one lesson we would draw is that if equity investors are banking both on stronger economic growth and further monetary easing to support current valuations, they are almost certain to be disappointed," Jessop said.

Traditionally, the second day of the Fed chairman's address is usually less market-moving than the first, and the major averages quietly sloshed around in positive territory Thursday. Bernanke delivered a stern warning regarding fiscal policy, but otherwise avoided much talk about future easing intentions.

That stood in contrast to Wednesday's stock losses as well as a $75 drop in gold [GCCV1  Loading...      ()   ] prices, a move that could be seen as a decrease in the inflation expectations that would come with a third round of quantitative easing .

"The response yesterday was breathtaking in its swiftness and violence and we are convinced that the response by gold and other markets was and is egregiously ill-advised and massively overdone," hedge fund manager Dennis Gartman said in his daily newsletter. "The Fed is not going to take away its punchbowl...but it appears that it will not be pouring anything into that same punchbowl for a while."

The other side of the argument, of course, is that the Fed moving away from its historic market intervention would be a sign of confidence.

Since the financial crisis began, the Fed has staged two QE bond-buying interventions as well as a third program called Operation Twist, which caused no net expansion of the central bank's $2.9 trillion balance sheet but did result in bond yields dropping even further.

"The Fed needs to get out of its crisis mindset," said Jim Paulsen, chief market strategist at Wells Capital Management in Minneapolis. "Would we really be focused on Greece if there was a legitimate crisis here to worry about?"

Instead, Paulsen said the Fed needs to start worrying more about the inflation its policies could cause. Rising bond yields later in the year actually could force the central bank to increase rates rather than go to even more accommodative policy, he said.

"I'm an advocate of the Fed starting to normalize its monetary policy with the economic cycle that's matured from crisis to recovery," Paulsen said. "You can still accommodate, but there's no reason to accommodate it with crisis policies any longer."

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Housing's Dilemma: When Having a Buyer Isn't Enough

Last week I wrote about how fewer foreclosures up for sale in the housing market could actually mean lower overall home prices.

That may sound counter-intuitive, given that we always talk about how distressed sales deflate comparable home prices.

My reasoning is that foreclosures are in high demand right now, and organic, non-distressed sellers are still not coming back to the market. Without the foreclosures, there really is no competitive market.

I hate to say, “I told you so,” but … today the National Association of Realtors reported that inventories of homes for sale in January fell to 2.31 million, the lowest supply since March, 2005. Rather than pushing home prices higher, they are still down, 2 percent, from a year ago.

The Realtors noted that 35 percent of all home sales were distressed (either foreclosures or short sales). Investor demand is high, they say, even claiming that a recent program initiated to sell the foreclosures of Fannie Mae and Freddie Mac in bulk to investors is unnecessary.

“Based on the swiftness of how REO (bank-owned) properties are moving in the market, it may not be needed,” said NAR chief economist Lawrence Yun. He did admit that such a program would also take away thousands of potential listings from Realtors.

Banks are ramping up the repossessions, as the so-called “Robo-signing” foreclosure paperwork scandal is fading and a settlement with federal and state governments has been reached. But they are not going to flood the market with these properties, for fear of losing pricing power. That’s why we are now starting to see bidding wars in some of the hottest distressed markets.

Sales of existing homes in the West, which comprise the hardest hit states of Arizona, Nevada and California, jumped 8 percent in January month to month. More than half of sales out West are foreclosures and short sales. Demand is definitely rising, but only on the lower end.

If you look at sales distribution by price, 69.9 percent of homes sold in November were under $250,000. That moved up to 72.2 percent in January. Given that there is just a two month difference, seasonality, i.e, higher priced homes selling at different times of year, doesn’t apply.

As I wrote last week, organic, non-distressed sellers are making up less and less of the overall housing market. That does not a healthy housing market make. Without good, move-up homes available, the market cannot see real price appreciation.

“The main limit on sales volume now is willing sellers, not willing buyers,” says Glenn Kelman, CEO of Redfin, a real-estate brokerage.

Questions?  Comments?  document.write("");document.write("RealtyCheck"+"@"+"cnbc.com");document.write('');And follow me on Twitter @Diana_Olick

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