In the Ring With the Fed

This column was originally published on RealMoney on Dec. 1 at 2:34 p.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

There's a battle going on between the Federal Reserve and the market over the outlook for the economy and the appropriate monetary policy.

In This Corner...

The Fed's position is clear; as it expected, the economy has slowed. However, as Chairman Ben Bernanke said recently, "Outside housing and motor vehicle sectors, economic activity has, on balance, been expanding at a solid pace." The Fed suggests that weakness in housing and autos is likely to be self-correcting and, in any event, unlikely to spill over and undermine the overall economy.

Fed officials have consistently argued that the upside risks to inflation are greater than the downside risks to growth. It has maintained what is tantamount to a tightening bias since pausing in its tightening cycle near midyear. Price pressures have not continued to accelerate but remain above levels that the Fed identifies as stable. The only dissent at the FOMC meetings has come from the hawks -- namely, Richmond Fed President Jeffrey Lacker -- favoring a rate hike. No one has voted to cut rates.

Equity-market participants would seem to agree with the Fed's assessment of a soft landing. Over the past month, the S&P 500 rose 2.4%, easily outperforming European bourses, which, outside of Spain, largely fell, and Japan's Nikkei, which posted a marginal loss.

And in the Opposite Corner...

The debt and currency markets are less sanguine. Prices of various instruments seem to reflect the fear of a harder landing.

Fed funds futures and the eurodollar futures imply that the Fed will likely cut its target rate in the spring. The yield curve -- almost any way you measure it -- has become more inverted, and that historically has been a fairly consistent precursor of an economic downturn.

The dollar itself has slid over the past few weeks, the slide ecoming especially pronounced over the past week or so. On a trade-weighted basis, it has declined by nearly 4% since mid-October, and more than half of that fall has been recorded since Nov. 20.

This change in the trade-weighted measure of the dollar is tantamount to some easing of monetary conditions. Economists may differ on the exact ratio, but the 4% decline in the dollar on a trade-weighted basis is roughly the equivalent of 25 to 40 basis points of easing, if it is sustained. In effect, then, the market has eased policy for a Fed that is reluctant to do so.