FYI | Aug 09 2006
By Greg Peel
The US stock market is currently balanced on a knife edge of uncertainty, and no more is this apparent than in the wave of volatility experienced since the Fed hiked less expectedly back in April. There is a feeling at present that no monetary policy result is particularly encouraging.
The Fed was largely tipped not to raise rates last night. Ahead of the decision it was difficult to tell exactly which way the stock market might run in either outcome. Normally a rate rise equals bad and no rate rise equals good. But things are no longer that simple.
Were the Fed to raise rates then the market would probably have been sold off as this would mean inflation concerns were still rife. However, a pause would mean that the US economic slowdown had, in the Fed’s eyes, progressed to a point where another rise might accelerate the slowdown and make a recession more possible. Either way, there appeared little of a rosy outcome for markets.
As it was, the Fed paused, but the language accompanying the decision provided no comfort that a pause signalled the end of the tightening phase. The Fed suggested that “inflation pressures seem likely to moderate over time” but it also suggested a close watch would be kept on developments. One Fed member actually dissented, which hasn’t happened since last year.
The Fed had also noted last month that productivity gains were keeping labour costs in check, but only this morning (US time) were labour costs figures published suggesting the opposite. This is not good news for inflation.
On the flipside, rising fuel costs and a weakening housing market are taking their toll on economic growth, meaning it may be time to let inflation have its own effects on the economy and hopefully achieve a soft landing, rather than exacerbate the situation with a rate rise and cause a hard landing (recession).
The US stock market had risen 3.0% since the last Fed meeting, one in which Bernanke’s comments were considered to be more “dovish”. The market got what it wanted – a pause – but with caveats. Hence it was probably safer just to take some profits, which appeared to be the case in the Dow’s 46 point (0.4%) fall.
As my esteemed editor has pointed out in his Weekly Insights, a pause in monetary policy tightening usually leads to a stock market rally, at least once the pause has been ratified. While lower interest rates are better than higher interest rates, stability is much better than uncertainty in the investment environment. Moreover, if a pause is cemented, it is likely the next move in rates will be down.
At this point, the Fed pause is anything but certain. We are likely to suffer ongoing volatility for a while yet. Investors may which to look to the Halloween Effect as an impetus for getting back in.
The “Halloween Effect” is the other end of the adage “Sell in May and go away”. It is “Buy in October”. This May-October dichotomy has been shown (with little explanation) to be a relationship that has stood the test of time across world markets for decades, even centuries, on a more often than not basis.
In other markets, oil pulled back under US$77/bbl after shooting up yesterday on the back of the announcement that BP’s Alaskan pipeline will shut down indefinitely. Things in the Middle East are hardly improving either. Gold pulled back in sympathy to be trading around US$640/oz at present, while base metals markets were quiet.