Rate-Cut Obsession Skews Market's Economic View

Tuesday's decision by the Federal Open Market Committee to cut the fed funds target rate by a half-point, rather than the three-quarter-point cut Wall Street was hoping for, did nothing for the market.

In the teeth of a decline that sent the Dow 238 points lower and pushed the Nasdaq down 94, about the only solace an investor could take was that the Fed left the door open for cutting rates before it meets again May 15.

"In these circumstances," said the Fed in the statement that accompanied the cuts, "when the economic situation could be evolving rapidly, the Federal Reserve will need to monitor developments closely." It was the same language the Fed used after its Dec. 19 meeting -- the one that came right before the Jan. 3 intermeeting cut, and a clear indication that the Fed stands ready to lower rates.

Most closely watched will be indicators related to demand, like consumer confidence measures and retail sales. So far, the consumer has held up pretty well, but there's a worry that the steady grind down in the stock market could damp demand. "You've eviscerated hundreds of billions in equity wealth just since the Tuesday meeting," notes Morgan Stanley Dean Witter economist Bill Sullivan. "The steady drive to lower stock valuations creates problems for the economy's potential."

That the markets are looking at economic data not so much for information on where the economy is going but what the Fed will do makes for an odd sort of trading dynamic. Last Friday, for instance, there was a good deal of disappointment in the market because the University of Michigan's Consumer Sentiment Index showed an unexpected rebound. This got people thinking that the Fed might not be cutting rates as aggressively as hoped, (true, it turned out) and was one of the things that provoked a pretty big selloff.

In fact, the improvement in consumer sentiment was a positive sign, suggesting that there may be light at the end of the tunnel for the economy, that growth could be poised to resume, that the profits recession corporate America is going through could come to an end sooner rather than later. It almost seems as though the market has decided it knows what's going on with the economy -- that it sucks and that it needs super-aggressive rate cuts -- and that it's not going to let the economic data deter it from that view.

"The market's not differentiating between the means and the end," says Miller Tabak bond strategist Tony Crescenzi. "Bad news is good news and good news is bad news. But what if the economy is improving? Isn't that meaningful? Isn't that positive?"

It's that kind of market environment that, potentially, could create a tremendous opportunity for investors. If signs arise that the economy is, in fact, beginning to strengthen and the market continues to view such signs negatively since they suggest a less aggressive Fed, then it could be possible to get into stocks before companies start announcing improved earnings and the rest of the world cottons to what's happening.

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