The Fed Interest Rate Hike

With the recent devastation of Hurricane Katrina and another storm on the way, there were many who believed that the Federal Reserve may interrupt there long string of rate increases, in favor of a wait and see attitude. Thus, the stock market has registered its displeasure with the Fed’s announcement of another .25% hike by selling off nearly 150 points. But we believe the stock market has it wrong because a close reading of the news release that accompanied the rate hike contains some good news about the long-term strength of the US economy. Before we analyze the Fed’s statement, it is important to remember that the Federal Reserve’s responsibility is to set interest rates consistent with maximizing economic growth and minimizing inflation in the long-term. The operative word here is long-term. The Fed’s accompanying statement stated the following regarding the impact of Hurricane Katrina: “While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity.” We believe their statement is very straight forward and very good news. The Fed is the most sophisticated economic data gathering entity in the world. They have looked at this data and other instances of natural disasters, and they have concluded that in the short-term the hurricane’s damage to the overall economy will be readily contained, and the long-term prospects for the economy are still very good. The Fed is making its decision to hike rates based on its long-term view of things, not the current news of the day. In our judgment, it is this focus on the long-term that has allowed Alan Greenspan and Company to navigate through countless crises during his 18 year reign as Chairman of the Federal Reserve. There are many politicians and media-types, who are lambasting the Fed’s rate hike as being insensitive to the plight of the suffering. To the contrary, if the Fed believes there are untamed inflationary pressures building, they would be just one more body of governmental body shirking their responsibilities if they took a pass. The stock market and some politicians may not approve of the hike, but we are actually encouraged with the language of the press release and relieved that the Fed believes, as we do, that Katrina will not take the wind out of the US economy in the long run.