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S&P 500 Sideways For The Second Straight Week As Financial Markets Are Confused About What The Fed Is Trying To Do

|Includes: SPDR S&P 500 Trust ETF (SPY)

by Ed Wijaranakula, NMS Investment Research

The S&P 500 closed at 2,183.87on Friday, practically unchanged for the second week in the row, despite a strong rebound of crude oil prices and encouraging economic data. The Labor Department said on Tuesday that the core CPI, stripping out food and energy costs, edged up 0.1% in July, or a 2.2% increase on a year-on-year basis. Inflation remains tame as the core CPI has been stuck in a range between 2.1 and 2.3% since December 2015, despite rising rents and medical costs.

S&P 500 Technical Chart

Separately, the Federal Reserve reported on Tuesday that total industrial production jumped 0.7% in July, compared to a 0.3% increase expected by economists in a Bloomberg survey. Capacity utilization rose to 75.9% from 75.4% in the prior month, said the Fed. Better-than-expected industrial production and capacity utilization data prompted the Federal Reserve Bank of New York to raise its third-quarter GDP forecast to 3.0%, from a previous 2.4%.

The U.S. Dollar index tumbled 1.25% for the week, to close on Friday at 94.483, despite Fed officials that were busy pumping up the case for September rate hikes. The yield of the 10-year U.S. Treasury Note continued to bump into technical resistance at about the 1.58% level, after hitting a record low of 1.37% on July 8, and closed at 1.58% on Friday. The yield spread between the 10-year and 2-year U.S. Treasury Notes was at 0.82 percentage points at the close on Friday, as recession fears persist.

DXY Technical Chart

On Tuesday, algorithmic trading on thin volume and stop-loss orders triggered yen buying and U.S. dollar selling, after the overseas market interpreted Monday's comments from President of the Federal Reserve Bank of San Francisco John Williams as dovish, in his economic letter posted on the bank's website.

In the letter, Williams said,

Although targeting a low inflation rate generally has been successful at taming inflation in the past, it is not as well-suited for a low r-star (natural rate of interest) era. There is simply not enough room for central banks to cut interest rates in response to an economic downturn when both natural rates and inflation are very low.

Things were more confusing from there, after the minutes from the July 26 and 27 FOMC meeting were released on Wednesday, revealing a deep division among FOMC participants. The Fed's Williams, a non-voting member of the FOMC this year, told Reuters in an interview on Thursday, "I think every one of our meetings should be in play in principle... I definitely think September should be", referring to an interest rate hike at the next FOMC policy meeting. Earlier in the week, New York Fed President William Dudley and Atlanta Fed President Dennis Lockhart also made strong arguments for rate hikes.

The WTI crude oil spot price continued to skyrocket, to close on Friday at $49.11 per barrel, up 10.38% for the week, while the Brent crude price jumped 7.8% for the week to close at $50.85 per barrel, following a weaker dollar, a bullish EIA oil inventory report and comments from Russia Energy Minister Alexander Novak. Mr. Novak told Saudi-owned newspaper Asharq al-Awsat on Monday that a complete return of market stability is only likely in 2017 and dialogue with Saudi Arabia regarding a possible deal aimed at achieving long-term oil market stability has progressed in "a tangible way", according to a Reuters report.

WTIC Technical Chart

Iran is still a wild card though, as its officials said in April that Iran wouldn't participate in any negotiations until it restored production to pre-sanction levels, between 4 million and 4.2 million barrels per day, or bpd, according to a Bloomberg report. On Tuesday, an Iranian press official told the Wall Street Journal that the country likely would not be pumping that much oil by September, ahead of OPEC's informal meeting.

The EIA weekly U.S. oil inventory report on Wednesday showed a decline of 2.51 million barrels to 521.1 million barrels, excluding strategic inventories, in the week ending August 12, compared to S&P Global Platts analysts' expectations for a drawdown of 200,000 barrels. The American Petroleum Institute, or API, inventory data on Tuesday showed a U.S. crude inventory drawdown of 1.0 million barrels for the week.

There was a decline last week in U.S. gasoline supplies of 2.7 million barrels, while distillate stockpiles, including jet fuel, diesel fuel and heating oil, increased by 1.9 million barrels, according to the EIA. Analysts were expecting a drawdown of 1.8 million barrels of gasoline stocks and a drop of 500,000 barrels for distillates.

Separately, the EIA said the weekly U.S. crude oil production increased by 152,000 bpd for the week ending August 12, 2016, to 8.597 million bpd. Weekly U.S. crude oil output has fallen about 10.54% from the peak level of 9.61 million bpd during the week ending August 12, 2015. Houston-based oilfield services company Baker Hughes Inc. said on Friday that the U.S. oil rig count was up another 10 from the previous week, to 406, compared to 316, when the rig count hit the low on June 6, 2016.

The best performing S&P 500 sectors for the week were Energy and Materials, up 1.97% and 1.27%, respectively. The worst performing sectors for the week were Telecommunication services and Utilities, down 3.84% and 1.29%, respectively.

S&P 500 Summary: +6.85% YTD as of 08/19/16
Barclay Hedge Fund Index: +2.68% YTD

Outperforming Sectors: Energy +15.55% YTD, Utilities +15.52% YTD, Telecommunication services +15.26% YTD, Materials +12.09% YTD, Industrials +10.11% YTD, Information technology +8.58% YTD, and Consumer staples +8.38% YTD.

Underperforming Sectors: Consumer discretionary +4.07% YTD, Healthcare +3.0% YTD, and Financials +0.39% YTD.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.