Markets Cast Worried Look as Fed Mulls 6th Rate Hike
As a strategy for avoiding financial heartache, this one has been unbeatable in 1994: Sell out of your stocks and bonds 15 days before the quarter ends. Go lie on the beach for a few weeks or so.
With the third quarter drawing to a close, the markets find themselves in the same painful situation that marked the end of the first and second quarters. Stocks are falling, bond yields are rising and the dollar is sinking.
And once again, investors are seemingly at the mercy of the Federal Reserve Board, which meets Tuesday to decide whether to raise short-term interest rates for a sixth time this year.
Will they or won’t they? The betting among economists, for what it’s worth, is that the central bank will leave rates alone.
Reuters news service polled 30 economists on Friday and found only five who expect a rate increase. While there is concern that the economy is still expanding at too fast a pace for the Fed’s liking, many Fed watchers believe that Chairman Alan Greenspan & Co. risk damage to their credibility if they act now.
After the last half-point rate increase, on Aug. 16, the Fed officially said it was finished boosting rates, “at least for a time.” One can argue about what exactly that meant, but many economists contend that there was an implied promise by the Fed to sit and digest a couple of months’ worth of data on the economy.
“They said they were inclined to wait,” says Gary Schlossberg, economist at Wells Fargo Bank in San Francisco.
Of course, the inflation hawks at the Fed could respond that the 0.6% rise in August wholesale prices reported on Sept. 9--the biggest gain in four years--was enough of a shock to warrant new action to brake the economy.
Likewise, reports last week on the July trade deficit and August housing starts also painted a picture of robust demand for goods and services in the U.S. economy.
But Allen Sinai, economist at Lehman Bros. in Boston, figures that Fed board members must be acutely aware that their five previous rate hikes this year may simply need more time to sink in. The Fed’s credit-tightening moves have raised the bank prime lending rate by nearly one-third since February, from 6% to 7.75%.
“The economy is slowing--but how much (the Fed) isn’t sure,” Sinai says. “Though inflation has ticked up, the question is whether the economy’s slowdown will take inflation back down in six months to acceptable levels.”
Like Schlossberg, Sinai figures the Fed will pass Tuesday. “I’d say its 60-40 that they don’t (raise).”
But what do investors really want to see--an inflation-vigilant Fed, or a more patient central bank that gives the economy the benefit of the doubt?
The bond market, at least, appears to be begging for another Fed rate boost. The 30-year Treasury bond yield has zoomed this month from 7.45% to 7.78%, a 27-month high. In theory, anyway, long-term bond yields are the best barometer of inflation expectations. If yields are up, bond investors are expecting the Fed to take a stronger stand against inflation.
But the stock market, which along with the bond market had rallied in mid-August and thus blessed the Fed’s Aug. 16 rate hike, may take a dimmer view of another rate increase so soon.
The National Assn. of Manufacturers said Sunday that a poll of its members showed the majority opposing a Fed rate hike this week. Their fear is that the Fed could crush the economic expansion.
Last week, a plunge in auto-related stocks helped take the Dow industrial average down 101 points for the week, to 3,831.75 by Friday.
The auto stocks’ slump may be a warning that further Fed rate increases would be greeted negatively by investors, not positively.
Dan Sullivan, editor of the Chartist newsletter in Seal Beach, contends that the bull market is dying a slow death at the Fed’s hands. The signs are unmistakable that investors are increasingly losing interest in stocks, he says.
During the powerful late-August rally in the Dow industrials, for example, rising stocks on the Big Board failed to decisively outnumber declining issues by the kind of ratio you’d expect to see if the market were readying a big move up, Sullivan argues. “Market momentum is invariably very weak at the end of bull markets,” he says.
Other Wall Streeters, however, see little difference between the latest stock selloff and the ones that struck at the end of the first and second quarters. These bulls view stocks’ losses as mild and temporary--a good time for bargain-hunters to be shopping.
Once healthy third-quarter corporate profit reports begin rolling in by early October, interest-rate concerns will recede again, says James Solloway, research chief at Argus Research in New York.
Rising corporate earnings “have been a major offset to the negative influence of higher interest rates,” Solloway says, and he doesn’t see that offset losing its power yet.
Yet as short- and long-term interest rates climb, the stock market is increasingly threatened by simple competition: At some point, money managers will find bond yields so enticing that they may sell stocks to buy bonds.
Are we there yet? Mary Jane Matts, director of equity research at $20-billion Society Asset Management in Cleveland, thinks so. The bond market has been in a horrendous bear cycle for nearly 12 months, she notes, while stocks have held up remarkably well. If you’re looking for value, she says, you’re more likely to find it in a 10-year Treasury note yielding 7.56% than in the typical stock.
“Stocks don’t look terribly overvalued until you compare them to bonds,” she says.
Just how attractive bonds have become relative to stocks may become evident this week, as the Treasury auctions new two-year and five-year notes. Notes of those maturities currently yield 6.49% and 7.19%, respectively.
If the public rushes into those securities--with or without a Fed rate hike--it could be a sign that investors are sensing at least a temporary top in rates. That could be better for the bond market than for the stock market in the near term, but it’s also not a stretch to suggest that, short of outright recession, what’s good for bonds will eventually be good for stocks.
* MANUFACTURERS SAY NO: A major interest group says the Fed should not raise rates. D9
