Markets Are Easing for Fed

Elevated inflation and inflation expectations are significant barriers to the possibility of interest rate cuts from the Federal Reserve. Another significant barrier is the behavior of U.S. financial markets.

This is not a negative development; it is actually good news for those worried that the Fed's sidelined status will hamper economic growth. That said, stronger growth is not necessarily all good; it could boost current inflation pressures.

Four powerful influences are providing stimulus to the economy, reducing the need for the Fed to counter the economic slowdown with interest rate cuts. Stock prices are up, the dollar is down, credit spreads are tighter, and bond yields remain low. In each case, there is a direct benefit to the economy.

For example, tight credit spreads encourage borrowing in the corporate bond market, and judging by the record amount of bond issuance that occurred in March, companies appear to be aggressively taking advantage of the low interest rate environment.

The weaker dollar will of course encourage foreign buying of U.S. goods, helped by the strong global economic picture, and higher equities prices will have a wealth effect, which many believe runs at about 4 cents on the dollar (meaning that for each dollar that a household's equity portfolio rises, personal spending increases by an additional 4 cents).

The indirect effects of the recent movements in the markets will also feed the expansion, by boosting confidence. There are limits to this, though, given that what ails the economy most is an excess of unsold homes. A sustained expansion lasting well into 2008 is needed to bring inventory levels back to equilibrium.

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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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