Fed interest rate announcement, Greek debt crisis to focus investor attention

TORONTO – Stock markets will likely be off to a subdued start this week as investors look to Europe for a resolution of the Greek debt crisis and to the U.S. Federal Reserve, which will be making its next announcement on interest rates on Wednesday.

At the same time, investors will take the pulse of the Canadian economy and hope the latest retail sales data will show a rebound from March.

This week’s Fed meeting is the last before the U.S. central bank’s latest round of quantitative easing, known as QE2, comes to an end at the end of June. The program, which the central bank uses to put more dollars into the financial system, has been a tool for stimulating the U.S. economy.

But investors hoping for another injection of stimulus into what Fed chairman Ben Bernanke has called a “frustratingly slow” economic recovery will likely be disappointed.

“I think basically the economy is on its own,” said Doug Porter, deputy chief economist at BMO Capital Markets.

“I think some of Bernanke’s recent comments have hinted along those lines that the Fed is not seriously considering QE3 at this point. He said things like monetary policy can’t be a panacea.”

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Rising levels of core inflation, which exclude volatile items such as food and fuel, are one reason the Fed will stand pat.

“That was one of the reasons why they considered QE2 (in 2010), because we were flirting with deflation,” said Porter.

“Well, since that time, headline inflation has gone up a lot but even core inflation (which excludes items such as food and fuel) has gone up. So, there is not as powerful an argument even on that front. So I think the Fed is more likely just to grin and bear a period of sluggish growth for the U.S. economy.”

The Fed announces its decision on interest rates at midday Wednesday and it is widely expected to leave rates near zero until next spring.

But the announcement will be followed later in the day by a news conference by Bernanke.

“That will give the markets a little bit more to chew on besides what is likely to be a mild statement,” added Porter.

“But I think in some ways he has already tipped his hand, I mean he said the recovery has been slow and disappointing and I think that’s going to continue to be the message next week.”

The TSX fell 2.24 per cent last week, its third straight weekly decline, leaving the main index down 4.85 per cent year-to-date and down 10.73 per cent from its recent highs of early March.

The Toronto exchange and markets around the world were also buffeted last week by worries that Greece will default on its massive debts.

Investors were more hopeful that won’t happen after Greek Prime Minister George Papandreou replaced his finance minister Friday in a broad cabinet reshuffle that won strong support from markets.

Also, Germany appeared ready to provide billions more to carry the debt-ridden country through 2014. German Chancellor Angela Merkel indicated that the private sector would not be forced to share in the pain of a second bailout.

Papandreou has struggled to garner support for a crucial new package of euro28 billion (US$39.5 billion) in spending cuts and tax hikes demanded by the EU and International Monetary Fund, which granted Greece’s first bailout fund last year in return for austerity measures. The package must be voted through parliament this month if the country is to continue receiving funds from its bailout.

“The best thing that could happen, (that) we could hope for is that they paper it over for now, we do come to some kind of agreement and basically Greece sticks to, carries through its reforms and its austerity measures and gets a grip on its finances,” said Porter.

“But even the best-case scenario will require very tough austerity and it will take years to turn around. I just don’t know if they’re up for that.”

Meanwhile, Canadian traders will look to the latest reading on retail sales on Tuesday. Economists believe that sales rose by 0.5 per cent in April following a flat showing in March.

Retail sales were just one per cent above year-ago levels in the first quarter while sales volumes fell at a 3.1 per cent annualized pace in the period.

“The bigger picture here is that Canadian consumers cooled their jets,” added Porter.

“The economy isn’t going into reverse or anything but I think things have clearly slowed down on that front after an amazingly good recovery.”

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