Fed Strikes Right Balance

The Federal Reserve took action and chose words that fit more closely with its dual mandate than was expected today, which, while not the best outcome for the markets today, is probably the best outcome for the economy and the financial markets in the immediate period ahead.

While the Fed's decision was not exactly a line in the sand on inflation --- the Fed did cut the funds rate by 75 basis points, after all -- it was strong enough, especially given the two dissents, to put the U.S. dollar on better footing and threaten speculators in the commodities markets.

I expect the dollar to be buoyed and commodities to fall in response to today's action and the Fed statement, if not immediately, then in hours or days.

The 75-basis-point decision and the accompanying statements on inflation Are, therefore, positive developments given that the Fed was seen recently as showing benign neglect toward the dollar. This should help turn the tide. Basically, any disappointment over the size of the rate cut is cancelled by the Fed's defense of the dollar.

A negative in terms of the initial market response was the lack of any new attention to the financial market problem. The Fed made only passing reference to the problem. This should not be a lasting problem, of course, given the mighty attention the Fed has put toward the financial market problem in recent days and weeks.

Below is the Fed's statement regarding inflation, and the inflation statement from Jan. 30. Notice the major change in attention paid to inflation and inflation expectations:

Jan. 30:

"The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully."

March 18:

"Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.

Notable are the two dissents by two Fed hawks: Fisher and Plosser, both of whom wanted a smaller rate cut. It was the first dual dissent since September 2002. Three dissents would be considered a mutiny, meaning that the defense of the value of the dollar has grown. This is a good development. Low inflation is always good for the economy and the financial markets.

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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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