Interest Rates

Critical Invasion

By, 03/21/2007

The scramble has begun! More art than science, more augury than empiricism, the pundits and pinheads are dissecting the Fed's newest statement, fresh off the presses. After each of the Fed's highly anticipated meetings usually clear-minded analysts…go completely crazy. Suddenly, these titans of finance all become literary critics.

They pore over each word of the Fed's comments and minutes as if they were working on a tricky passage in Oedipus Rex for their dissertation about Freudian patricidal overtones in Sophocles. What's the deal!? First, the facts.

The Federal Open Market Committee decided to keep its target for the federal funds rate at 5.25%. Stocks surged on the news. The S&P 500 finished over 1.7% higher and the Nasdaq rose 1.8%. The dollar fell, long rates fell, and fed fund futures fell. All, seemingly, because of the Fed's statement. Below are the significant language changes versus the same statement last meeting.

Firmer economic growth was changed to reflect mixed indications
Stabilization in the housing sector was changed to reflect ongoing adjustments continue
• Contradicting the market response included a direct reference to the risks that inflation could fail to moderate and the possibility of future policy adjustments
• Modest core inflation improvements was changed to reflect somewhat elevated inflation

What should stock investors make of all this? Nothing. That's what. In the end, all that matters is what the Fed does, not what it says. Jawboning is for short term market movements only. Over the last year or so, at some meetings the Fed sounded hawkish…and didn't move rates. For others it sounded dovish…and didn't move rates.

To be fair, the market is trying to assess the future of rate movements. Markets are all about the future, and so in some sense a collective market analysis and pricing of Fed expectations is precisely what markets should be doing. But that doesn't mean it's useful for disciplined stock investors to react in the same way.

Most of this frantic misconception of Fed-speak comes from the idea that the Fed "drives" the economy with its refilling or taking away of the liquidity punchbowl. It's far better to think about whether the Fed is doing harm to the economy.

We've said many times in this space that free market economies grow. That's what they do in their natural state. It takes major policy or regulatory blunders to undo this natural tendency. The question is whether the Fed is doing something to harm the economy, whether the policy is appropriate.

Right now, it's very difficult to argue the economy is not on solid footing. Inflation has ticked up a bit, yes, but in no imminent danger of rampancy. Unemployment is at multi-year lows. Corporate profits are still very healthy. Stocks are holding up nicely despite all sorts of irrational concerns. Long term interest rates remain very accommodative to new investment.

Nothing's changed all that much since the end of 2006. Growth is good but not gangbusters, and inflation is for the moment only a concern. Things still look healthy and the Fed is holding pat—balancing these issues very nicely. We see that as entirely appropriate.

And while the market seems to agree today, ultimately the movement of stocks isn't determined by the Fed but by fundamentals and economic results. Leave the literary analysis to the stuffy Shakespearean scholars and stick to the data.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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