Beware of What You Wish For
Market Views of Comstock Partners, Inc.
Thursday, June 30, 2005
For the stock market, today’s FOMC statement was more important for what it didn’t say than for what it did. What it didn’t say or even hint at was that the current round of tightening would end anytime soon. This is something that market participants want very badly although we would remind everyone that sometimes the worst thing that can happen is to get what you wish for.
In fact the statement was largely a non-event with only a couple of minor changes from the prior FOMC statement on May 5. The Committee called the economy “firm” instead of saying it “slowed somewhat”. It also stated that “Pressures on inflation have stayed elevated” as compared to May, when they said “Pressures on inflation have picked up in recent months”. Overall, the Fed’s statement comes across as somewhat hawkish on rates with its stated view that the current policy is still “accommodative” while the economy is “firm” and inflation is “elevated”. However, to make sure that investors remain calm they continue to talk about increasing rates at a “measured pace”.
As we’ve stated in previous comments, we believe investors pay entirely too much attention to parsing each and every word of the FOMC statements that follow policy meetings. The Fed is tying itself into verbal knots trying to tighten monetary policy without getting the markets overly concerned. In doing so the otherwise admirable goal of being more transparent is entirely defeated by the nature of the prose. 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 consistently retain the “measured pace” phrase, they say that they will nevertheless respond to needed changes, meaning they are not restricted in terms of changing future policy in either direction.
In our view, what matters now is not the wording of the FOMC statements, but the fact that the Fed is in a tightening phase, yield spreads are narrowing rapidly, money supply growth is exceedingly low, oil prices are at record highs and global economic growth is softening. All of these factors have historically been harbingers of significantly slower economic growth, most often leading to recession. When this slowdown becomes apparent the Fed will stop tightening and even begin easing no matter what previous statements said, and a stock market suddenly facing the prospect of an unexpected falling economy and drop in earnings is likely to decline sharply.
© 2005 Comstock Partners, Inc.
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