The equity market can't win for losing. Then again, neither can
Chairman Alan Greenspan, so that's probably not surprising.
A month ago, certainly six weeks ago, there were
fears the Federal Open Market Committee would tighten at today's policy meeting. Those fears faded as the economy cooled, so much that there was more recent concern the central bank would alter its risk assessment statement to one weighted toward economic weakness.
Given that, you'd think the Fed's decision today to leave both the fed funds rate at 1.75% and its risk assessment unchanged at "balanced" would have brought some measure of cheer to the beleaguered stock market. Instead, major averages fell notably from intraday highs reached shortly after the 2:15 p.m. EDT release of the
Once as high as 9919.03, the
Dow Jones Industrial Average
closed up 0.3% to 9836.55, while broader averages fared worse. The
fell 0.3% to 1049.49 after having traded as high as 1058.67 while the
closed down 0.3% to 1573.82 vs. its intraday best of 1594.57.
Stock market participants were apparently put off by the Fed's comment "the degree of the strengthening in final demand over coming quarters, an essential element in sustained economic expansion,
is still uncertain
." (Italics added)
Greenspan, meanwhile, is increasingly being viewed as oblivious to the inflationary implications of keeping the fed funds rate at a 40-year low despite recent increases in commodity prices, weakness in the dollar, steepening yield curve and gains by Treasury Inflation-Protected Securities.
The Fed made no mention of inflation in its statement today, save for the tacit acknowledgement monetary policy is "accommodative," noted Mickey Levy, chief economist at Banc of America Securities.
At 1.75%, the so-called real fed funds rate is negative, i.e. less than the annual rate in core CPI or 2.4%, and certainly less than the 3.8% growth in the Cleveland Fed's CPI over the 12 months ended in April. Admittedly, fed funds is above the 0.6% year-over-year growth in real personal consumer expenditures, a Greenspan favorite that is included in the GDP report.
"Negative short-term real interest rates are consistent withrecessionary conditions, but inconsistent with healthy economic growth," Levy commented. "In fact, healthy productivity-driven economic growth raises real interest rates, and the Fed must eventually hike its funds rate target commensurately." (The Fed was obviously unmoved by today's preliminary report that first-quarter producitivty rose 8.6%, the highest level since 1983.)
Levy, a member of the shadow open market committee, believes the Fed appears unlikely to wait until its August meeting to "initiate a series of rate hikes."
But that might be too late from the bond market's perspective, and politically difficult ahead of the midterm elections in November, according to James Bianco, president of Bianco Research in Barrington, Ill.
"It's a dangerous game the Fed is playing," said Bianco, a
longtime critic of Alan Greenspan. "The 1.75% fed fund rate was an emergency reaction to Sept. 11 when
the Fed thought the economy was going to go to hell. This is the second meeting in a row the Fed said the risks are neutral, so why do we still have emergency fund rates?"
Bianco's answer to his own question was that "more and more the Fed appears to be wanting to micromanage the economy. That's a nice way of saying they want the stock market to go up and people to buy routers
and they will do whatever's necessary with the funds rate to help promote that."
Speaking of routers,
reported fiscal third-quarter earnings of 11 cents a share after the bell today, vs. expectations for 9 cents and year-ago results of 3 cents. It will be interesting to see how Cisco's upside surprise will impact stocks tomorrow, especially given news of another suicide bombing attack in Israel. (Early indications are that Cisco will hold sway as both it and equity futures were higher in after-hours trading.)
But Bianco bristled at the Fed's "hubris" of believing it can "create a little inflation" to help the stock market and then "rein it in" thereafter, without any ill effects. Recent trends in commodity prices, the dollar, TIPS and the yield curve suggest the market is "very worried about what the Fed is doing here," he said.
The bond market could "have a seizure" if it believes the Fed has gotten too far behind the inflation curve, Bianco said. It hasn't had one recently and didn't have one today because the Fed's lack of action was widely anticipated. The benchmark 10-year Treasury note rose 1/32 to 98 20/32, its yield dipping to 5.05%. The two-year note, which is most sensitive to changes in the fed funds policy, ended up 2/32 to 100 16/32, its yield falling to 3.11%.
But today was the Comp's lowest close since Oct. 9, and at that time the 10-year was yielding 4.59% and the two-year 2.73%. That bond yields are higher now is "the inflation worry imbedded in the market," Bianco said.
The only reason bond yields aren't higher still is "bond guys are hoping the Comp trades under 1000," he suggested. "If that's too pessimistic and stocks are setting up for an oversold bounce, then the bond market will look at the 1.75% fed funds rate, say 'we don't have a crashing stock market' and could have its seizure."
Just for kicks, Bianco mused that if the stock market's rally doesn't get under way until after July 4, the FOMC's August meeting could occur with the bond market screaming for a rate hike but the midterm elections just three months away.
In such a scenario, Alan Greenspan would find himself in a box of his own making. Then again, he should be familiar with that position by now.
More True Confessions
As a side note, Bianco said he was in "stunned agreement" with what Griffin, Kubik, Stephens & Thompson economist Brian Wesbury wrote in yesterday's
Wall Street Journal
. "I didn't expect that from him but he was totally correct," Bianco said.
I concur. When I detailed
Wesbury's transformation from deflationist to inflation hawk earlier today, I didn't mean to imply otherwise.
However, I recall getting a lot of heat for being a worrywart and a fear-mongerer by daring to quote sources like Bianco who long ago suggested inflationary pressures would re-emerge when the economy recovered. Don't economists who were warning about the "ravages of deflation," as Wesbury was last December, deserve similar attention?
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.