Morning Update

Traders Look to Fed, White House

Stocks are up modestly in early trading ahead of the Fed's two-day meeting that begins today and expectations that the White House will eventually propose a bailout of the auto industry. Crude oil has come off recent lows and is approaching $50 per barrel after OPEC reiterated that $75 per barrel is a fair price and the market is oversupplied with oil, suggesting a cut is in the works at the December 17 meeting. So far, OPEC's announced cuts of about 2 million barrels per day have been unable to offset the slide in demand and stem a near collapse in prices. Separately, equity news is light, with Honeywell International offering 2009 profit guidance, and Northern Trust announcing layoffs. Treasuries are mixed, the Empire Manufacturing Index fell slightly, while Europe is higher but banks are looking at their exposure to Bernard Madoff's failed hedge fund. Asia ended in positive territory.

As of 8:35 a.m. ET, the December S&P 500 Index Globex futures contract is 6 points above fair value, the Nasdaq 100 Index is 6 points above fair value, and the DJIA is 37 points above fair value. Crude oil is up $2.79 to $49.07 per barrel, and gold is up $4.40 per ounce at $324.90. The overnight LIBOR rate was unchanged at 0.12%. The three-month LIBOR rate dipped another 5 bp to 1.87% in anticipation of a rate cut by the Fed tomorrow.

Fed, production, inflation in the spotlight

The economic calendar will be jam-packed this week with major economic reports that will probably reflect an economy that is in the worst recession since 1982. Comments from the FOMC and the interest rate decision tomorrow following a two-day meeting are likely to take top billing amid talk from policymakers that more unconventional measures to support sagging demand are on the way. A survey by Bloomberg indicates that analysts are expecting a 50 bp cut in the fed funds target to 0.50%, the lowest rate in modern times; however, the move may be viewed as largely symbolic since the benchmark rate has averaged 0.33% since the late October meeting due to the Fed's actions to pump up interbank lending. Despite flooding the system with money (sometimes referred to as quantitative easing), the rate has held above zero because banks place excess reserves back on deposit at the Fed and receive a small amount of interest.

What is clear is that the Fed is running out of room to reduce interest rates and some analysts believe the expected rate on Tuesday may be its last as there has been a subtle shift away from emphasis on the price of money - fed funds rate - to the supply of money. In the October statement, the FOMC acknowledged that "extraordinary liquidity measures" are being taken. Following the decision to buy mortgage-backed securities in November, Fed Chief Ben Bernanke remarked that the Fed could buy longer-term Treasuries in "substantial quantities" to spur economic activity. The press release may not detail actions that are being contemplated but it is likely to point to a continued or accelerating loss of jobs, concede that demand is contracting, and signal that downside risks remain high. Short-term inflation problems are likely to get little if any play, but worries that disinflation could be replaced by deflation have crept into recent Fedspeak.

Other top-line reports that are worthy of mention include industrial production and capacity utilization just before market open. A 0.9% decline in production and drop in capacity utilization from 76.4% to 75.6% is anticipated, providing a clearer picture of the industrial sector since the Boeing strike and hurricane's earlier in the year clouded activity. The NAHB Housing Market Index will also be released early this afternoon and is expected to hold at the dire reading of 9.0.

Tuesday's release of the Consumer Price Index is expected to show that prices fell at a 1.3%, eclipsing October's record 1.0% drop due to quickly falling oil prices. Back-to-back record declines in the CPI are likely to heighten talk that deflation will become a problem, and given the speed at which demand is contracting, deflation is a risk; however, oil prices won't remain in a freefall and retail price declines could quickly moderate if crude stabilizes. Inflation Succumbs to Deflation. Housing starts and building permits will also be released tomorrow. Data picks back up on Thursday with the release of weekly jobless claims, the Leading Index, and the Philly Fed's Business Activity Index, with each expected to show that the labor market and economy are still under considerable stress.

Elsewhere, the Empire Manufacturing Index fell from -25.4 in November to -25.8 in December, less than a forecast decline to -28.0. Prices paid fell into negative territory, dropping from 6.0 to -11.7 as demand recedes and commodity prices decline.

Higher commodity prices aid Europe

Gains in energy, mining, and steel shares are leading a modest rally in Europe as raw material and energy prices firm, but losses in the banking sector are limiting the advance. BNP Paribas (BNPQY $30) is solidly lower after disclosing that it put as much as 350 billion euros with US investor Bernard Madoff, who allegedly ran an investment scam that may have bilked investors around the world out of up to $50 billion. Banco Santander (STD $9), the second-biggest bank in Europe by market value, placed over 2 billion euros of its clients' money with Madoff's hedge fund. Royal Bank of Scotland (RBS $17) has up to 400 million pounds at risk. The Sweden-based home appliance maker Electrolux (ELUXY $19) is also under pressure after cutting its full-year profit guidance and announcing layoffs due to falling demand for its products.

Tokyo jumps on hopes of auto bailout

The Bush administration said on Friday that it is considering using some of the $700 billion from the US Treasury's TARP program designed to assist financial institutions for the auto industry, sending the Nikkei 225 Index in Japan up by 5.2% and offsetting a dismal reading on corporate sentiment. Shares of Honda (HMC $22) jumped 8.5% and Toyota (TM $63) rose nearly 10%. But the White House said early Monday that an announcement is not imminent.

The influential Tankan survey of business sentiment plunged 21 points in 4Q to -24, just below the estimate of -23 and the biggest drop in 34 years. Slumping demand around the world is being exacerbated by a strong yen, while major companies in Japan have announced layoffs and cost cutting, accentuating concerns that a recession in the world's second-largest economy behind the US will worsen.