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Economy's Gain Is Becoming Market's Loss

A strong gross domestic product report Friday isn't likely to test the Federal Reserve's patience but could once again test the market's.

After an 8.2% jump in the third quarter, GDP is expected to rise at a 5% annualized rate in the fourth quarter, with strength coming from almost every segment.

"This is going to be the most balanced [report] we could ever see," said Joel Naroff, chief economist at Naroff Economic Advisors. "Consumers have continued to spend, it looks like residential construction is going to be good, exports have been growing, clearly business investment is up and we know the government has been spending like crazy."

Although economic growth undoubtedly slowed from the third quarter and some of the strength in the last three months of the year was a result of continued fiscal stimulus, Naroff said the report is likely to prompt further speculation about a hike in interest rates this year.

"Strong growth is going to fuel the belief that the Fed will start moving away from" its accommodative stance, he said.

On Wednesday, the Fed left interest rates unchanged at 1% but dropped its commitment to keep rates low for a "considerable period." Instead, it vowed to remain "patient in removing policy accommodation". Investors immediately jumped to the conclusion that the Fed would hike rates later this year and stocks and bonds sold off.

David Rosenberg, chief economist at Merrill Lynch, said the market overreacted to the news just as it did in 1996, when Fed Chief Alan Greenspan gave his "irrational exuberance" speech. Back then, investors thought the Fed would raise rates to curb the action in the equity market but by the summer of 1998 -- some 18 months later-- the fed funds rate was little changed and the Dow had gained over 1,000 points.
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