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We've all been waiting expectantly for the "Phantom Menace" to appear. The newspapers have been speculating about it and many people have organized their lives around its appearance. Oh, I don't mean the new George Lucas movie; rather I mean the threat by the Federal Reserve Board of Governors to raise interest rates in the face of potentially increasing inflation. In late May, when inflation numbers appeared to be up, the Fed announced a "bias toward" raising rates. This is not in itself unusual: the Fed in the past several years has sought to tip off the market to its intentions (tighten, neutral or easy) by releasing the gist of its regular meetings. The big news this time was that the announcement was made immediately following the meeting, rather than with the usual six week lag. Market analysts and Fed watchers (yes, such a breed exists--talk about needing a life!) interpreted this to mean that the Fed would be raising rates in the near future. But then a funny thing happened. On the basis of this interpretation of the Fed's actions, investors sold bonds and rates rose. In effect, the market did the Fed's job for it! Here's the beauty of monetary policy. If the Fed raises rates, that's a drastic move that can turn the economy around. It wants to avoid that effect at all costs. If it simply does something a little out of the ordinary--like advancing and announcement by six weeks--the market will do its job for it and do it much more gently. Now the bond market, waiting for the other shoe to drop will operate cautiously, rates will stay higher and attract funds for the stock market. This, in turn, will slow down the Dow's growth and begin to slow the economy. Nice deal, huh? How does this affect you? Well, don't look for interest rates to come down in the near future, that being defined as the rest of the year. But don't expect the Fed to raise rates either. That's unlikely unless the inflation numbers keep mounting. I don't think that's likely, but don't trust me. Turn yourself into an economic forecaster and watch the inflation numbers--released each month and widely reported in the press--for your self. If they stay high, the Fed will move. If they settle down, then monetary policy will remain unchanged. |
