Party pooper
Greenspan moves to stave off inflation, spooking stocks
Alan Greenspan's career as an economic seer, prodigious as it has been, might also be reduced to a series of cute acronyms. Start with WIN. That was the Whip Inflation Now campaign of the '70s when Greenspan headed President Ford's Council of Economic Advisers. Through much of his Federal Reserve Board chairmanship in the late '80s and '90s, Greenspan was an inflation hawk.
At the start of this decade, deflation and recession became the real bugaboos facing the economy. So Greenspan turned to a strategy that you could call SIN, as in Start Inflation Now, if only to get the economy going.
But now that the Fed has won the war on deflation and the economic expansion is more than three years old, the central bank's strategy is shifting once again--and the markets are getting woozy.
On the rise. This time, let's call it SPIN, or speak out about inflation now (while also downplaying its threat). This shift became clear last week when the Fed raised interest rates for the seventh time since June, bringing the federal funds rate--which banks charge one another on overnight loans--to 2.75 percent.
The Fed also did something it hasn't done for a while: warned investors about the "I" word. "Though longer-term inflation expectations remain well contained, pressures on inflation have picked up in recent months and pricing power is more evident," the Fed's Federal Open Market Committee said.
That sent the markets into a tizzy. The Dow Jones industrial average, which traded as high as 10,984 in recent weeks, sank to 10,430 following the Fed's move. "When the Fed worries about inflation and states so explicitly, you'd better believe the markets will worry about inflation," says Stuart Hoffman, chief economist for PNC Financial Services Group.
The downdraft continued with the price of crude oil hovering near $55 a barrel and consumer prices showing a rise of 0.4 percent in February, slightly above expectations. The new worry about inflation, and especially the notion that companies were starting to pass along increases in the cost of wholesale goods, has cast a pall over the stock market that some strategists believe could be a turning point for investors big and small.
While the ability to raise prices may be good for corporate profits in the short run, inflation is bad for consumers in the long run--and their spending accounts for some two thirds of the economy. Already, rising interest rates helped pushed mortgage rates above 6 percent for the first time since last summer.
Though rising rates are certainly good news for savers who are holding cash, fixed-income investors, especially those nearing retirement, face the daunting prospect of structuring bond portfolios just as interest rates are climbing. Higher rates lower the value of older lower-yielding bonds, which could lead to losses in fixed-income portfolios.
For investors in general, these are nervous times. Since 1972, the S&P 500 has typically lost ground in periods of rising prices. Financial and consumer discretionary companies, such as the automakers, tend to be hit the hardest during such times.
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