Stocks sulked Tuesday afternoon after the
Federal Open Market Committee
delivered the longest-discussed "pause" in history. The Bernanke-led Fed concluded its August meeting by keeping interest rates steady at 5.25% despite evidence of rising inflation.
Prior to Tuesday's decision, the Fed had raised rates by 25 basis points at 17 consecutive policy meetings over the past two years. Investors had hoped for a pause for over a year -- since Dallas Fed President Richard Fisher famously said the tightening cycle was in its "eighth inning" last June.
Now that the much-anticipated pause is here, the markets are more confused than ever, perhaps because inflation is rising and Bernanke still leaves investors perplexed by his communication style.
"The reaction is a disappointment that the Fed didn't shut the door on further tightening," says Art Hogan, chief market strategist at Jefferies & Co. "The market would have rather seen them tighten than leave the book open on this particular cycle. People thought we might be done, so people are concerned."
Bernanke doesn't give the classic Greenspan sound bites that investors hang their trades on. He requires investors to believe in his economic-forecasting skills without many ground rules. Long gone are expectations that Bernanke would be an inflation-targeting type. His "comfort zone" for inflation has shifted higher over the recent months. And, despite the obvious rise in inflation, the FOMC's statement Tuesday was virtually unchanged from June -- and more dovish than expected.
The central bank reiterated its data-dependency and its belief that slowing growth should help dampen inflation. "Inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand," the statement says.
For market participants who try to discount today what likely will happen six months from now, the data-dependent lack of certainty is torture.
"This is the faith-based Fed policy," says James Bianco, president of Bianco Research.
The stock market expected to hear more about inflation from the credibility-challenged Bernanke on Tuesday, especially if the Fed paused. Instead, the Fed removed its previous statements about productivity keeping inflation contained. The argument no longer worked given the Labor Department's report earlier Tuesday that productivity growth rose 1.1% in the second quarter, much slower than the 4.3% gains in the first quarter. Unit labor costs rose by a faster-than-expected 4.2%, compared with a 2.5% increase in the first quarter.
The stock market was flummoxed. While the major indices were slightly up ahead of the FOMC's 2:15 p.m. EDT announcement and jumped modestly on the news, they finished the day in the red.
Dow Jones Industrial Average
ended down 0.41% to 11,173.59, while the
dropped 0.34% to 1271.48, and the
slipped 0.56% to 2060.85. Since the Fed started raising rates in June 2004, the Dow is up 7.8%, the S&P is up 12.2% and the Nasdaq has risen 2%.
Corporate news took a backseat Tuesday as earnings seasons winds down and traders awaited the Fed decision. But some merger activity did move individual stocks and helped inspire the broader market's early gains. The headliner was
agreeing to acquire
for $713 million in stock. Brocade dropped 18.4% on the news while McData 14.4%.
said it would buy
disclosed plans to take over rival
, an aluminum products company, jumped 27.7% after agreeing to be bought by private equity firm Texas Pacific Group, while
Reynolds & Reynolds
gained 11% on news it will be bought by privately held Universal Computer Systems.
Elsewhere, shares of
were recently up 9% in after-hours trading after the company posted strong earnings and its CEO forecast stronger-than-expected revenue growth in 2007.
The prices of Treasuries, which had rallied sharply in the weeks ahead of the Fed meeting, were mixed on the news. The 10-year note yield climbed only 2 basis points to 4.92%. The shorter-duration bonds reacted more as the five-year note added 3/32 to yield 4.84%, while the two-year note yield gained 3/32 to yield 4.9%. The 10-year yielded 4.73% in June 2004.
The dollar is little changed after the FOMC statement.
The Fed says "that some inflation risks remain," but Tuesday's statement emphasized the Fed's data-dependency in delivering the long-telegraphed pause. "The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information."
Economists are skeptical about the Fed's rosy outlook, as many note that "incoming information" points to uncomfortably high inflation.
"Following four consecutive elevated core inflation releases and a 44-month period in which 12-month headline inflation has run above core inflation, and with the economy still showing ample momentum, as well as noting past policy difficulties caused by excessive reliance on a tradeoff between economic momentum and inflation pressures, we believe that today's FOMC inaction may increase the risk that an inflation psychology could gain a further foothold, necessitating more tightening and greater risk to the economy in the future," writes Peter Kretzmer, senior economist at Bank of America.
The decision to pause was not unanimous, as Richmond Fed President Jeffrey Lacker voted to boost the fed funds rate by another 25 basis points. Market participants were unusually mixed about their expectations for the FOMC ahead of the release, as the fed funds futures market had priced in a 21% chance the Fed would hike. The fed funds futures market now prices in a 20% likelihood the Fed will raise rates in September.
Wednesday's headlines may be about "When Does the Fed Ease?" as Bianco quips. But if Kretzmer's forecast comes to pass, the Fed won't have enough evidence for an ease or another unchanged decision on rates. If the Fed is forced to hike, the market won't remember that Bernanke and the Fed kept indicating that
pause means pause, and that data-dependent might mean a resumption of hikes. And the Fed will look like it missed the boat.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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