Don't Fear the Fed!

Tomorrow morning Fed chairman Greenspan will again testify before Congress. Markets are on pins and needles awaiting his words. But will they really matter?

Greenspan’s tenure at the Fed began in 1987 and has been marked by a strong emphasis on making the Fed’s monetary policy as predictable as possible. The Fed wants to avoid surprising markets if it can. Tomorrow’s testimony will be no exception. I think that after the smoke clears following the Greenspan’s testimony you will find the bond market pretty much where it closed today.

This brings me to a more important point. If the Fed wants to be as predictable as possible then the markets have already discounted whatever interest rate increases the Fed has planned. So you have to look elsewhere for guidance as to the future direction of the bond and stock markets.

It is worth wondering why the stock market has moved gradually higher since March 2004, a period during which the Fed has raised short term interest rates 200 basis points. In the business of speculation it is the dog that doesn’t bark that often is the critical clue to the future. In this case a 200 point increase in rates would normally be expected to have a depressing effect on stock prices. The fact the averages rose a little bit instead means that underlying demand for stocks is very strong. This is a very bullish condition.

I am reminded very much of 1994. The Fed raised rates several hundred basis points in 15 months, but the stock market didn’t budge. When the Fed let it be known that it was near the end of its series of increases, what happened? Stock prices soared and the great stock market boom of the 1995-2000 began.

I expect a mini-version of this situation to be repeated now. The Fed will soon halt (temporarily) its moves towards higher rates and stock prices will advance 15-20%.

Don’t fear the Fed!