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Feb 4, 2004 Last week the Federal Reserve shook markets by removing a phrase from their familiar policy statement that indicated their inflation concerns may shift in a more rapid manner than previously expected. The market reacted on fears that the Fed will respond to perceived inflation by raising interest rates in order to put the damper on any chance of a runaway economy. It appears that those fears, particularly in relation to inflation, are largely unfounded. A couple of days after the release of the Fed’s policy statement, the gross domestic product (the GDP) report was released, and it indicated an entirely different picture than what the market was reading into the Fed statement. The gross domestic product grew at a 4 percent annual rate, as measured in the just completed fourth quarter. This is a decrease of over 50 percent from the previous quarter, where the GDP grew at a rate of 8.2 percent. Analysts had predicted that the GDP would grow at approximately 5 percent, and the 4 percent actual rate indicated the economy has slowed down more than anticipated by the experts. The slowing GDP can be translated into a decreased possibility of inflation. Although market traders exhibited disappointment in the GDP growth rate, as viewed by the initial direction of the various markets after the data was made public, a longer view points to a favorable result for stocks. The slower GDP growth rate indicates that the Fed won’t be as likely to take action on rate raises in the near future. In fact the slowing of the GDP growth rate indicates that the Fed can put off raising rates for longer than what the market anticipated earlier in the week. So the bad news is actually good news in the long run and the markets should adjust in the next few weeks. Other indicators point to the same conclusion. Rebecca Byrne writes in a Street.com column that “the Fed’s favorite gauge of inflation – the core personal consumption expenditure price index – rose at an annual rate of just 0.7 % in the fourth quarter, the lowest quarterly gain since 1962.” That bears repeating – the Fed’s favorite gauge of inflation had its lowest increase in over 40 years. This is quite significant for the near future. The fact that the Fed puts a lot of weight on this indicator also adds to the presumption that the Fed won’t raise interest rates for quite some time. And to top off the data, Monday’s edition of the Wall Street Journal included a review of the minutes of the preceding Fed meeting, where inflation fears were not readily evident among the members views. Inflation does not appear to be on the horizon for as far as can be seen. TheStreet.com article by Byrne quoted UBS chief economist Maury Harris as saying “the GDP report offers no reason to anticipate tightening any sooner than the August timing we have projected.” He goes on to note that “Indeed, inflation in the report remained tame, although that was not a surprise.” Maybe not to his group, but apparently it was a surprise to some on the Street. Harris (and UBS) point to an August time frame for a possible upward adjustment of the Fed rate. That seems to fall in line with what the markets had been leaning toward before the most current statement spooked everyone. Some analysts think that any possible increase won’t come until after the Presidential election in November as Greenspan and the Fed most likely won’t want to affect the election one way or the other. There is even an outside chance of no rate increase until well into 2005. The decreased prospect of inflation is a prime reason that the Fed doesn’t have any compelling reason to adjust the rate upward for some time. The markets will most likely recognize this in the coming weeks and resume an upward march. The most recent GDP rate, though nowhere near the scorching rate of the previous quarter, is still a descent rate compared to the past couple of years. The economy appears to be shaping up nicely for an extended period of good gains without raising the immediate specter of inflation. ------------ About the author: Dwayne Hines currently has 12 books selling in major bookstores and writes for major magazines such as Physical and FitnessRX. Email Dwayne Hines: dhines@3dinet.com Comment on this column in the forum. Tell a friend about this site! ------------ |
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