After a wave of top economic event risk, the US dollar has come through this past week with a more promising outlook for growth as well as diminished potential for a Fed rate hike this year. After the policy board announced its intentions to hold the benchmark lending rate at 2.00 percent and offered rhetoric that was more or less in line with the group’s middle-of-the-road commentary from previous months’ statements, the probability that the central bank would raise rates by the end of the year dropped from 71.6 percent to 59.9 percent. However, with evidence that the financial and credit markets are stabilizing, economic activity is turning up from the worst and upstream inflation is cooling, the Fed may be emboldened to tighten well before the consensus and continue to raise rates to a level well beyond the 75bp over the next 12 months overnight interest rate swaps are currently pricing in.

Risk aversion is still tangible in the credit market, but concerns that we may be thrown into another crippling crunch are certainly easing. For yet another week, rates on default protection and the junk bond spread were little moved. Such calm despite the considerable write downs from Deutsche Bank, HSBC and Freddie Mac among others suggests both investors and lenders have been reassured by the Fed’s efforts to secure liquidity and prevent another potentially serious market failure.

The health of the credit market is still far from the ‘normal’ levels of only two years ago; but the Fed’s actions have clearly improved confidence such that investors are moving back into debt with longer duration and greater counter-party risk. Two policy efforts by the policy board may offer the final push to correcting the market. First, the central bank announced it would extend its emergency loans to Wall Street through January 30th of next year. Second the NY Fed is pushing to establish a clearing house for credit default swaps by year end.

The capital markets have pulled back from extremes and revived investor confidence. News that economic activity rebounded through the second quarter and the Fed would remain on hold with monetary policy led to a sharp turn in stocks. Another promising turn of events for equities traders was the steep retracement in commodities markets. In fact, this past Monday, the benchmark Reuters/Jefferies CRB Commodities Index marked its biggest one-day decline since last March while the composite pushed to its lowest overall level since early April. This move was no doubt heavily influenced by the remarkable drop in WTI crude, which the media has branded as being in an official bear market after retreating more than 20 percent from its record highs. However, despite these improvements, commodities are still high on a historical basis and the stock market is just off 18-month lows. Caution is still a necessary trait for investors in this environment.

Stocks are back in the green, but the change from last week is actually very small. From a docket fully packed with earnings releases and macro economic data, the most promising news for shares was confirmation that the Fed wasn’t boosting rates and that we may have already passed the worst for economic growth. On the other hand, 11,700 has proven a difficult level to surpass with the financial sector still recording significant write downs and consumer-related firms marking slower sales.

Like the underlying price action in equities, market condition indicators have improved while still yielding to a level of resistance. The S&P volatility index was back below 22 percent, but there has been a notable area of support with many investors still concerned about the low level of the benchmark indexes and the potential for new multi-year lows. Similarly constrained was the Put/Call ratio which has pulled back from two month highs, but stopped short of marking equally remarkable lows.

While the outlook for the US economy has improved significantly with the second quarter GDP release, the burden on consumer sentiment is still increasing. Though growth recovered, personal consumption over the same period merely ticked up from a 12 year low. Additionally, the more timely consumer-related indicators are certainly not supporting expectations for the economy to maintain its pace through the current three-month period. A consumer spending indicator for June clearly reflected the come down after the government’s tax rebates. Americans’ true financial positions are reflected in the 1.9 percent drop in disposable income and the seventh consecutive drop in employment through July. With the unemployment rate at a four-year high, borrowing costs still at multi-year highs and the housing recession deepening the consumer may thwart any true economic recoveries.

The leading, consumer-based indicators coming across the wires this past week stood in stark contrast to the improvements in the severely lagging reports (a concerning juxtaposition for the dollar outlook). For sentiment, the ABC gauge fell for a second week as the measures for the buying climate and personal finances dropped. For ailing employment, there seems to be no end in sight for NFPs as initial jobless claims jumped to the highest level since April of 2003. Finally, spending habits will be curbed by the ongoing crunch in housing market. Mortgage approvals ticked up from a seven year low as the average 30 fixed rate mortgage rate is near a one year high.

The outlook for economic activity is likely more mixed than recent activity in the markets would suggest. While second quarter GDP rose to a 1.9 percent annualized clip, there were notable revisions to the two previous readings (the fourth quarter number actually reflected the first contraction in growth since 2001). Such revisions remind us that this is just an initial number and it could change dramatically a couple months down the line. What’s more, the economy’s largest sectors are clearly not in the condition to support a rebound in growth. Employment and wages are tumbling (pinching consumer spending), while both manufacturing and service activity is stagnating.