The Big Pause: Wall Street, Economy Love a Quiet Fed
Happy anniversary, Ben Bernanke!
A year ago, the Federal Reserve Board that you lead voted to raise short-term interest rates for the last time, on the theory that after 17 rate hikes between 2004 and 2006, economic growth was finally slowing.
As it turns out, you were wrong—but happily so.
Last year at around this time, gross domestic product, the broadest measure of U.S. economic activity, was growing at an annual rate of around 2 percent. And for the rest of 2006 and the first quarter of 2007, growth remained sluggish at best, though the economy never stopped growing. Today, as the Fed gathers for yet another regularly scheduled meeting to discuss the nation's interest-rate policy, the economy has seemingly reaccelerated and is growing at around a 3 percent pace. This explains why no one is expecting the Fed to cut rates at this meeting, as an economy that's already humming doesn't need a jump-start. This take by Morgan Stanley economist Richard Berner is typical: "Fed officials probably will not change monetary policy, nor will they likely signal that any change is forthcoming soon. Incoming data suggest that the outlooks for both inflation and growth are improving, just as policymakers have hoped...We continue to expect that monetary policy will be on hold through the end of 2007."
As far as inflation goes, it turns out that the Fed didn't need to raise rates after its June 28-29, 2006, policy meeting to curb rising prices. The previous hikes were more than enough to do the job. Consider this: The last time the Fed raised rates, so-called core consumer prices—i.e., consumer prices excluding energy and food costs—were rising at an annual rate of around 2.6 percent. Today, after a year without any Fed rate hikes, core inflation is growing only around 2.2 percent. This explains why no one expects the Fed to raise rates at this meeting.
The fact is, the economy and the markets have done remarkably well during this so-called plateau period. Plateau periods in the economy are defined as the time between the last in a series of Fed rate hikes and the first in a new series of Fed rate cuts. Typically, this is an interval marked by economic uncertainty, as the central bank has historically overshot with rate hikes. In other words, the Fed has historically raised rates beyond what was necessary to slow the economy to the point of tipping it into recession.
This is why in the average plateau period going back to 1970, stock prices have typically been flat. If you count all plateau periods since 1970, the Standard & Poor's 500 index of blue-chip stocks has gained only around 3 percent on average. If you throw out those plateau periods following a single rate hike—not a series—then the S&P 500 has actually fallen on average by 2.1 percent, according to Sam Stovall, chief investment strategist for Standard & Poor's.
But this is no average plateau. In fact, since the last Fed rate hike at the end of last June, the S&P 500 index of blue-chip stocks has soared more than 22 percent. Meanwhile, long-term-bond yields are about the same as they were back then, with the yield on 10-year treasury notes at around 5.1 percent. This implies that the bond market is not worried about either an economic slowdown or inflation.
And while market watchers were praying for a Fed rate cut earlier this year—in hopes of prolonging the current bull market—it sure doesn't seem like this bull needs much help from the Fed.
After all, if the Fed finds it necessary to cut rates, that would be a sign of a weak economy. But amazingly, a year after the Fed last raised rates to slow down the U.S. economic engine, the economy keeps chugging along. Indeed, a recent survey by Merrill Lynch found that a majority of money managers—54 percent—think the U.S. economy will actually be stronger a year from now than it is today.
In other words, the Ben Bernanke-led Fed may have accomplished something that even former Fed Chairman Alan Greenspan would be envious of: not a soft landing, but an economic reacceleration with no landing at all.
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