Your Economy (No Politics)

[Bullwinkle]

Fed Follies
Market Views of Comstock Partners, Inc.
Thursday, May 5, 2005


The utter absurdity of the detail paid to the minutiae of the FOMC statements was never more clearly illustrated than it was last Tuesday, when the Fed rushed to revise its previously-issued statement with a bare 5 minutes left before the market close. With the market sinking rapidly and the Dow down at 10208, the revision sparked the result apparently desired by the Fed—a 52 point jump in the final 5 minutes. Since we are not conspiracy theorists we accept the Fed’s explanation that the whole thing was an inadvertent error on the part of a staff member, and that the missing sentence was in the original draft. We do find it odd, however, that the Fed itself somehow pays less attention to the wording of the statement than virtually every economist and strategist on Wall Street, and that the revision was rushed out right before the market close at a time when prices were in a free-fall.

Actually, though, the Fed pays a great deal of attention to the wording of its statements, which, under the guise of transparency, are geared toward influencing markets and softening the harsher aspects of their real actions. Compared to the March 22 statement, the current edition gave some recognition to the softening of the economy and the pressures of inflation while, at the same time, sounding somewhat sanguine about the overall outlook.

On the economy, the prior statement said that, “Output evidently continues to grow at a solid pace”, while the current release changes that to, “recent data suggest that the solid pace of spending has slowed somewhat”. Whereas last time they stated that, “…labor market conditions continue to improve gradually”, this time they qualified it a bit by adding the word, “apparently”.

As for inflation, even after the addition of the omitted sentence there appeared to be some increased concern about rising prices. In the prior report the FOMC asserted that, “The rise in energy prices, however, has not notably fed through to core consumer prices.” The current statement left that sentence out, although this time it wasn’t a mistake. Presumably, they no longer felt comfortable saying that prices were not feeding through, yet did not want to alarm the markets by saying that prices actually were feeding through.

In our view the Fed is tying itself in verbal knots trying to tighten monetary policy without getting the markets overly concerned. They say that the upside and downside risks to the economy and inflation are equal, but that it depends on appropriate monetary policy. Since they can never say that their monetary policy is inappropriate, the risks must obviously always be equal as long as this caveat remains. In addition, although they retain the “measured” word, they will nevertheless respond to needed changes, meaning they are not restricted in terms of changing or not changing future policy.

In our view, therefore, investors pay entirely too much attention to slicing and dicing the words in the statement, and not enough attention to the true implications of Fed tightening. In the vast majority of cases where the Fed instituted a series of rate hikes, the economy softened significantly or went into recession, while the stock market suffered a serious decline. With the present economy more dependent than ever on rising asset values, we believe the risks to the economy and stock market are exceedingly high. This is particularly so in view of the massive structural imbalances, excessive valuations and high energy prices. Keep in mind that the consensus of economists has never successfully predicted a single recession, and that the consensus of market strategists has never successfully forecast a single bear market. In our view the forecasting record of tight monetary policy is a far better gauge of future conditions than the cheerleading type of chatter emanating from various “experts”.

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