Monetary Tightening Negative for Stocks Market Views of Comstock Partners, Inc. Thursday, March 24, 2005
Without saying anything that everybody didn’t already know, the FOMC on Tuesday was able to jumpstart the long-bond rate by changing only a few words and phrases without deviating from the usual quarter-point fed funds increase, or eliminating the controversial “measured” word from the post-meeting statement. The release was so nuanced that it is difficult to remember that, until fairly recently, the Fed did not even bother to say whether or not they changed the rate, and left it to an army of interpreters on the treasury trading desks to let us know. In a move to greater transparency the Fed began to release its rate decisions immediately after the meeting, and, in time, started to tell us what they think about the economy and where rates were likely to go. Two meetings ago they even started releasing the minutes three weeks after the meeting, giving investors yet another clue to the Fed’s thinking, and, of course, allowing the FOMC to manipulate market opinions even more without actually having to do anything substantive.
The Fed post-meeting release first indicated that they thought the economy was stronger. The February statement said that “output appears to be growing at a moderate pace”, whereas, in the current release “appears” was changed to “evidently” and “moderate” was changed to “solid”.
Showing their concern about inflation, the prior statement said “Inflation…remains well-contained”. This was changed to “…pressures on inflation have picked up in recent months and pricing power is more evident. The rise in energy prices, however, has not notably fed through to core consumer prices.”
On their views of future risk, the last release said,” The committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability to be roughly equal. With underlying inflation expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.” In this week’s statement the FOMC added the caveat, “with appropriate monetary policy action”, and substituted “should be” for “to be”. In addition the words “relatively low” were replaced with “contained.”
Although In every other respect the two statements were identical, the subtle changes were enough to catch the markets’ attention. Immediately after the release, the long-term bond rate soared, the dollar gained renewed strength, stocks tanked and commodities fell.
In our view, though, this is all typical late-cycle phenomena. The key point is that the Fed is tightening, and this has almost always been a harbinger of a declining stock market and economic slowdown or recession. This has been true at any level of interest rates—it’s the direction that counts. Combined with soaring energy prices, this is a potentially lethal combination given the glaring structural imbalances and an overvalued stock market. The stock market’s latest upside breakout to cyclical highs has already failed and fallen back into its base. Although an oversold rally is entirely possible, any downside violation of the 1163 level on the S&P 500 is likely to be particularly damaging.
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