Wednesday's Brew - Fb 21

Enjoy your fresh coffee with our summary and analysis of the market activity of the day and a medley of important information you should find useful. The Dow Industrials, S&P 500 and NASDAQ Indices are all lower through midday trading, driven by this morning's report of a higher than expected increase in consumer prices.

OVERSEAS MARKETS

Concluding its two-day meeting, the Bank of Japan raised the government benchmark rate a quarter percentage point today, to 0.5%. The decision passed on an 8 to 1 vote, but the bank indicated that there were few signs of inflation, and that it expected the economy to continue growing. The BOJ also stated that it would proceed slowly with any future adjustments. Full text of the BOJ statement provided is available here. The NIKKEI 225 slipped 0.14% today on the news.

While markets in mainland China will be closed all week, shares in Hong Kong reopened trading today. The Hang Seng Index performed without a post New Year's hangover, climbing 0.41% on the day.

While Asia was closed before the news broke in America, Europe was impacted today by the CPI data release. The DJ STOXX 50 Index was down 0.71% as a result, in our view. Despite Tony Blair's announcement that Britain would sharply reduce its troop levels in Iraq soon, the FTSE 100 was preoccupied with the American CPI report as well. The FTSE Index dipped 0.53% on the news, through late afternoon trade. The CAC 40 was down 0.49%, while the DAX slipped 0.35%.

ECONOMIC DATA & ANALYSIS

The January Core Consumer Price Index, which excludes volatile food and energy, was reported today 0.3% higher, a reading above the median expectation for a 0.1% increase, as compiled by Bloomberg. Year over year, core consumer prices rose 2.7%, ahead of the 2.6% reported in December. The Fed's preferred figure is the personal consumption expenditures index, which the Commerce Department reported on February first. That index rose 2.2% in December, and remained above the 2.0% level that sets off the Fed alarm. The CPI information was the main reason stocks opened lower today, as it's well understood that the Federal Reserve is focused on keeping inflation under control.

Last week's PPI data revealed inflation levels that the market could embrace, but today's CPI data, which is held closer to the hearts of Fed governors, showed the unexpected tick higher. Fed Chief Bernanke's warm words last week were enough to persist as long as today's data did not raise eyebrows. However, in light of the result, we believe any market rise that may have been driven by the Federal Reserve's golden forecast, has now been tarnished some.

As if a poor CPI reading wasn't enough to cut the market's party short, weekly mortgage applications showed housing continues weak. Mortgage applications declined 5.2% in the week ended February 16th, despite a decrease in borrowing rates. The purchase index, which measures new loans for home purchases, fell to its lowest level since October 2006, while refinancing activity declined 5.4%. We believe this data provides evidence for our thesis that housing has not yet bottomed, and that 2007 will mark another year of decline in starts and pricing.

January Leading Indicators were reported today at 10:00 a.m., and the consensus of Bloomberg economists expected an increase of 0.2%. The actual reading showed an increase of 0.1%, lower than expected. Though positive, the weaker than expected reading when combined with the CPI data provides a clearly negative environment for stocks today.

Also important today, the Fed will release the minutes from its January meeting. While the result of the meeting itself had a positive impact on equity markets, the contents of the minutes could have a completely different result. The Fed's brief statement following the meeting contained language referencing the ongoing risk that inflation could pose, and the fact that the Fed might have to act against it. Therefore, we expect the minutes to show hawkish discussion regarding inflation, and with this morning's CPI measure, this could impact the market rather negatively later today. In other news, Fed Vice Chairman Donald Kohn is addressing a group in Washington.

COMMODITY MARKETS & GEOPOLITICAL NEWS

Today marks the 60-day deadline for Iran to cease nuclear fuel activities, including uranium enrichment, as imposed by the United Nations. The International Atomic Energy Agency (IAEA) is scheduled to report today on the progress of Iran, and its compliance or noncompliance. It has become clear that Iran has remained steadfast in its efforts, and the report should show that Iran has continued enrichment.

With the USS Stennis now the second U.S. aircraft carrier present in the Persian Gulf, tensions have risen. Iran continues to test new and old missile technology, implying that it is preparing for an attack via the air. It's new air defense system is now reinforced by state of the art Russian technology, and its home grown missile system includes an ability to reach U.S. forces in Iraq and Israel, Saudi Arabia and Kuwait.

While Congress has acted to pass legislation denying the president his Iraq troop increase and to require he consult and receive Congress' approval for any initiative against Iran, these measures are nonbinding, because we believe they conflict with constitutional law. We suspect the President has positioned forces to defend allies and U.S. forces in the region, and anticipate it equally likely that Israel could push forward alone or in concert with the United States. We view Israel's time-line even shorter than the term constrained Bush. The current pace of filling of the strategic oil reserve implies an early 2008 U.S. initiative, but Israel may be more concerned with the pace of Iran's enrichment progress. WTI crude futures are fractionally lower this morning.

STOCK SPECIFIC NEWS
Kellogg Co. is presenting at the Consumer Analyst Group of New York meeting in Arizona, while the earnings report schedule for Wednesday includes Medco Health Solutions, TJX Companies, Analog Devices and Whole Foods Market.

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