Fed Misses Real Economy Again

From "One Percent Wonder" to Five Percent Blunder?

The Fed's inflation rhetoric today is just as misguided as its deflation expressions last year. Only nascent, disinflation pressures are visible:

• The real estate bull market is history.

• New capacity and demand destruction are bringing commodity prices back into balance.

• Many service prices are flattening after large increases.

• Even the government appears to be getting serious about health care costs.

While not obvious today, I can envision a legitimate 2%-3% headline inflation rate over the next 24-36 months.

But if the Fed does not throttle back its rate hikes, it risks throwing the entire economy into a premature recession. I can accept the Fed's jawboning as an attempt to raise risk premiums in the financial markets; investors had become too complacent in this respect.

However, serious restrictive forces are already at work in the economy today. They just need time to work through the system. One year from now consumption will be lower, savings higher and the impact from higher energy prices and interest rates will be present. Why not pause for a period to measure the impact of these forces on the economy before stringing together another round of rate hikes? The Fed has already successfully engineered a midcycle pause. Why jeopardize it?

The Fed should not risk the recovery with an interest rate "rebalancing" effort that smacks the financial markets and the real economy over the head. Quite simply, it screwed up taking rates to 1%. It should not botch, bungle or flub normalizing short rates. Sometime the hardest thing to do is nothing. We need a big dose of nothing from the Fed for the next year.

What does this mean for equities? Should the Fed signal an end to the rate hikes, stocks will rally. Economically sensitive shares -- many down quite a bit from their highs -- should rally the most. I prefer selective positions in many "chicken cyclical" sectors including industrials, raw materials, technology, retail and financials. In my next column, I will share some more individual names that should benefit from a rate-pause-induced rally.

Alan, do investors, employees and homeowners a big favor. Don't go out with a bang, but rather, with a whimper.