Wednesday, March 21, 2007
As expected, the Fed just announced that they are leaving interest rates unchanged. What did bring a smile to the markets' and to former Fed Chairman, Alan Greenspan's lips, was the very slight change the Fed made to their "leaning" language. For the last six months, they have proclaimed a balanced attitude between the forces of inflation and economic growth, and that "leaning" caused them to end their long string of rates hikes. In today's announcement, their "leaning" language shifted ever so slightly to more concern about slowing economic growth than inflation. As I said in my last post, that is what Alan Greenspan has been advocating, and, apparently, Mr. Greenspan's former charges were looking at the same economic data he was. Even this morning, I read where several noted economists were advocating a rate hike because of the high core CPI rates. They don't live in the real world. The economy has entered a slowing phase which often causes inflation to blip higher because of lost productivity. Thus, to look only at inflation statistics is to look in the rear view mirror. The real picture is being played out in the unfolding crisis in the subprime lending arena. The Fed and Mr. Greenspan know that this crisis will spillover in some way at some level into the prime real estate market and slow the overall economy. Remember this: Greenspan does not use one of those fancy GPS navigational instruments to pilot his car. He watches the road. The road is a lot more unforgiving and confounding than the GPS map, which does not show pot holes, stoplights, or other two-ton cars that may have lost their way. I believe the Fed has now signalled that they will soon cut rates. This poses a conundrum. The economic news and corporate earnings are likely to soften over the next year, but US stock prices are likely to continue rallying. Just as core CPI lags the actual underlying trend of inflation, US GDP growth lags changes in interest rates. If the Fed is poised to cut rates, that will be favorable for stocks even if the economy and earnings begin to slip.