The Fed Seems Bemused, Wall Street Acts Confused
No clear signals ahead of tomorrow's Fed meeting on interest rates
Investors pushed stocks up, then down last week as the economy sent mixed signals ahead of a pivotal Federal Reserve meeting tomorrow.
And whatever the Fed decides, more volatility could be in store. While some analysts think investors would shrug off a rate increase, others say stocks could plunge.
That's what happened in late March, when the Fed stepped on the economic brakes for the first time in three years, boosting short-term interest rates 0.25 percentage point. Stock prices of major companies fell nearly 10 percent over the next few weeks.
"We will see a plummet in both the stock and the bond markets" if the Fed makes another move tomorrow, forecasts Peggy Farley, managing director of AMAS Securities, in New York. "The market has already assumed the Fed will not raise interest rates."
In a recent survey by Blue Chip Economic Indicators, two-thirds of economists predict the Fed will leave rates alone. Their case was bolstered Thursday, when the Commerce Department said consumer prices rose a scant 0.1 percent. That followed a big drop in wholesale prices.
Then Friday's report of a 2.6 percent jump in housing starts in April caused investors to turn tail. They figured the economy may not be slowing fast enough to please the Fed. After setting a record Monday, the market closed the week flat.
A third of economists see rates rising. Many say that with unemployment at a mere 4.9 percent, the Fed must raise rates or see wages and inflation move higher.
Unemployment is not at an "inflation-safe" level, says Tim O'Neill, chief economist at Harris Bank in Chicago.
Uncertainty about the Fed breeds uncertainty in the market.
Where Ms. Farley predicts a stock plunge from a rate hike, William Helman, director of investment policy at Smith Barney, expects little impact - barring an unexpectedly steep increase.
"The market could breathe a sigh of relief and say it isn't going to happen again for a while," he guesses.
"A great deal depends on the way the Fed pitches it to the market," says James Grant, editor of Interest Rate Observer.
If, "with a wink and a nudge," the Fed hints somehow that this hike is the last one, the market may take it favorably, he explains.
"There are enough people out there expecting the Fed to tighten that I don't expect a rude surprise in the market," says Michael Flament of Wright Investors Service in Bridgeport, Conn.
The Fed's goal is to keep the economy at a noninflationary pace. But chairman Alan Greenspan also appears worried that stocks may get so overpriced that a speculative "bubble" develops in US markets.
That happened in Japan in the late 1980s. Then the bubble burst, and the country is still recovering from the deep recession that followed.
Last December, Mr. Greenspan questioned whether American investors were displaying "irrational exuberance."
An even blunter warning followed earlier this year.
That prompted tough questioning when Greenspan appeared before the House Budget Committee in March.
"Why have you, on two occasions, taken to jawboning the US stock market and the US bond market with your comments to affect a free and open market?" asked Republican lawmaker Jim Bunning of Kentucky.
Greenspan insisted he had neither the intention nor the power to affect stock market prices.
H. Erich Heinemann, of Heinemann Economic Research, New York, maintains that when the Fed pumped money into the economy from 1991 to 1993 to pull it out of recession, most of the money went into stocks, not tradable goods and services.
It's hard to predict whether new money will go into the real economy, inflation, or financial markets, he says.
Some economists see a slowdown for business activity in the months ahead: less construction spending, a decrease for inventories, and some reductions in government spending.