Wednesday, July 05, 2006
[RealEdge] TodayOnline : What happens after the Fed stops raising rates?
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| What happens after the Fed stops raising rates? Expect markets to celebrate? It pays to remember that they often reward contrary opinion Wednesday July 5, 2006 Chet Currier news@newstoday.com.sg Bloomberg After two long years, the United States Federal Reserve looks to be at or near the end of its campaign to raise interest rates. The Fed has made no promises, saying it will base future decisions about "any additional firming" on information still to come. Also, it is possible the Fed will pause now, having raised short-term rates from 1 per cent to 5.25 per cent, and then decide a few months down the road that still more increases are needed. However the details play out, the day has drawn closer when the US central bank reaches the enough-is-enough point. That's the way it has always gone as the Fed follows the cyclical process of trying to steer the economy on a stable-growth, low-inflation course. It will happen again this time, no matter how hard it may be to call the turn in advance. That's the beauty of being a long-term investor: No need to guess the unguessable. Looking to the long term, one can focus instead on more distant matters, such as what is likely to happen in the markets after the interest-rate increases stop. If we assume that rising rates have lately been to blame for falling stock and commodity prices, we would expect those markets to celebrate after the rate increases cease. But the festivities might quickly fade as new questions demand to be answered. Did the Fed stop too soon, or go too far? Has it acted wisely enough to keep inflation in check without causing a recession? The last time the Fed announced the first of a series of reductions in the overnight bank rate, the stock market failed to muster a rally of any consequence. Hark back to January 3, 2001, when the Fed cut its target rate for the federal funds from 6.5 per cent to 6 per cent. That marked an inflection point, for sure. The rate, which had risen from 5 per cent over the previous 18 months, was destined to be cut 12 more times in the next 2 1/2 years, to a rock-bottom 1 per cent. In that first week of 2001, stocks were almost two years from reaching the bottom of a bear market. According to Bloomberg data, in the six months after that first rate reduction, the Standard & Poor's 500 Index declined 7.8 per cent and the Nasdaq Composite Index lost 18 per cent. That broke a pattern of consistent gains that followed the previous six transitions from rate increases to rate cuts. By my back-of-the-envelope calculations, in the six-month periods following all seven turning points from increases to decreases dating back to 1984, the S&P 500 had averaged a gain of better than 10 per cent and the Nasdaq more than 13 per cent. The problem is, the strongest showings occurred in the midst of a historic bull market. Stocks soared from mid-1982 through the end of the century as investors saluted a successful campaign by the Fed to subdue inflation. By the early 2000s, attention had turned to the threat of deflation. That new source of concern could easily haunt the market more if higher interest rates cause growth to falter in the US and other economies. Be especially wary of statements declaring that certain types of stocks big or small, growth or value are likely to perform the best when the next Fed easing starts. Yes, a check of recent history shows that the Nasdaq outdid the S&P 500, which is dominated by bigger stocks, more often than not in the six-month stretches after Fed turning points. But no, the pattern didn't hold every time. The S&P 500 outshone the Nasdaq twice in a row, after turning points in 1989 and 1995. Some market recoveries, it seems, draw their energy from revived enthusiasm for smaller growth stocks; others feature a more cautious nibbling at big-name blue chips. With all these caveats, it's still possible to be bullish about the outlook for Fed policy. For starters, so many people have negative things to say on this subject that optimism looks like the contrarian position and markets often reward contrary opinion. The Fed isn't dealing with virulent inflation, only a slight step-up. It also isn't faced with a severe recession, only what looks like a mild slowdown in growth. That leaves it with plenty of manoeuvring room to get the current turning point right. The writer is a Bloomberg columnist. The opinions expressed are his own. | |
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// posted by Shajahan @ 10:14 AM 