Merrill watching stocks for Fed hints

The Federal Reserve’s unending string of interest rate hikes has surprised some investors this year and there is no guarantee the central bank is done, a top Merrill Lynch strategist said on Monday. Richard Bernstein, Merrill Lynch’s chief investment strategist, said the equities sector that shows leadership over the coming weeks could be a signal of whether or not the Fed could pause soon. Financial markets show upward of an 80 per cent chance that the Federal Open Market Committee will raise rates by one-quarter percentage point after its June 28-29 meeting, but a limited chance—about 33 per cent—for an additional rate increase in 2006. Uncertainty about the rate outlook, in part, encouraged Merrill Lynch to alter its portfolio balance in May, raising the cash component to 20 per cent versus a 10 per cent benchmark. At this point ‘‘the markets are trading more on Fedspeak than on economics,’’ Bernstein said. He said the US Treasury yield curve, which last week returned to a small inversion, was a key indicator to watch. The US 10-year Treasury yield is currently trading just below the 5 per cent fed funds rate for the first time since early 2001. “If you could only follow one indicator though time, it would be the slope of the yield curve,” he said. Still, Merrill Lynch analysts assess only a 5 percent chance of a U.S. recession in 2007, Bernstein said.