While You’re Waiting . . .

If he doesn’t raise interest rates today, Alan Greenspan should get an Academy Award: Best Fake-Out Performance by a Federal Reserve Board chairman.

Greenspan’s numerous recent warnings about the need to be “preemptive” against inflation guarantee at least a quarter-point rate boost when the central bank meets, most Wall Streeters believe.

And then what? That is the financial markets’ most vexing question. Unless you employ a truly talented psychic, in the near term investors who are mulling whether to buy, sell or hold stocks or bonds will have to pick a Fed/markets scenario they’re comfortable with and invest--or not--accordingly.

For now, Wall Street certainly seems braced for bad news. In fact, a rise in the Fed’s benchmark short-term rate, the so-called federal funds rate, from the current 5.25% has become so widely anticipated--driving stock prices down and bond yields up in recent weeks--that markets actually rallied Monday.

The Dow Jones industrials soared 100.46 points to 6,905.25 and bond yields eased, in what some analysts saw as an attempt by investors to front-run any “relief rally” that could occur today if indeed the Fed finally acts, tightening credit for the first time in more than two years.

But figuring out Greenspan & Co., and markets’ likely reactions to the central bank’s attempts to fine-tune the economy via interest rates, is rarely a simple exercise, especially when the Fed is making money tighter rather than looser.

For investors and savers, the direction of stock prices, bond yields and bank savings rates in the near term will depend not so much on the Fed’s actions today, but what it does in ensuing months.

Here’s a look at the potential implications of a Fed tightening move for various markets, and what investors should consider as they weigh buy and sell decisions in coming months:

* U.S. stocks:

Many investors know instinctively that a stingier Fed is almost always bad for stock prices. By definition, when the Fed is raising rates it is trying to slow the economy by removing some of the grease--that is, money--that makes business and markets go.

The last time the Fed was in tightening mode was in 1994. Between February 1994 and February 1995, the central bank doubled the federal funds rate--the rate banks charge each other for overnight loans--from 3% to 6%.

The Fed’s first rate increase in that cycle was just a quarter of a point, on Feb. 4, 1994. But Wall Street was so stunned that the Dow industrials plunged 96.24 points, or 2.4%, to 3,871.42 that day.

The decline continued, erratically, until early April, shaving nearly 10% from the Dow. And for the rest of 1994, stocks were under pressure as the Fed continued to tighten. The Dow gained just 2.1% for the full year, and most broader stock indexes were down between 2% and 9% in 1994.

*

This time around, however, no one is going to be surprised by a Fed rate increase. Partly in anticipation of such a move, the Dow is down 2.5% from its March 11 record high. And most broader stock indexes have fallen much more: The Nasdaq composite index of mostly smaller stocks has already plunged 10.5% from its record high set on Jan. 22.

Does that mean a quarter-point rate hike is already factored into stocks’ prices? Maybe. But many Wall Street pros believe that soon after today’s rate increase, assuming it occurs, investors will focus on the bigger question: How much more tightening will the Fed do before it decides the economy is slowing enough to keep inflationary pressures at bay?

“I think the immediate refrain [on Wall Street] is going to be, ‘There’s more to come,’ ” said Jeffrey Applegate, market strategist at Lehman Bros. in New York. And that, he said, is likely to mean further downward pressure on stocks, slicing as much as 10% off the Dow in coming months.

Charles Pradilla, strategist at Cowen & Co. in New York, says the good news is that, with its benchmark short-term rate already at 5.25% (versus just 3% in 1994), “the Fed will not have to go into a prolonged series of rate increases” to achieve its desired goal.

On that most pros agree. Still, will Greenspan want a half-point rate boost in all, meaning a quarter-point now and another quarter at the Fed’s May 20 meeting? Will it take three-quarters of a point?

Pradilla figures that until “Greenspan’s final agenda is clear, or until the economy slows, we’re still in a correction” in stocks--historically, the normal reaction to higher interest rates.

If there’s one thing that could make investors try to forget about the Fed, however, it’s corporate earnings. If first-quarter earnings reports, which will begin to flow in mid-April, are better than expected, many pros say the market could lift off again.

But that’s also the big risk. If earnings fall short of expectations, stocks will have not just one, but two serious strikes against them, Applegate notes.

* Foreign stocks.

The Fed’s decision to raise rates in 1994 hurt many foreign stock markets much worse than the U.S. market. Will this be deja vu all over again?

So far this year, many key markets--especially in Europe and South America--are holding up much better than the U.S. market. Abby J. Cohen, strategist at Goldman, Sachs & Co. in New York, thinks that may continue, especially for emerging markets.

Her reasoning: In 1993, U.S. investors were pouring money into foreign stocks--a flow that abruptly shut off when the Fed began to raise rates. Today, the U.S. money flow into foreign shares is much smaller, Cohen notes, and so an interruption wouldn’t be such a huge shock.

Second, many analysts say that unless investors begin to believe that central banks in Europe and Japan will soon follow the Fed in tightening credit--something that appears unlikely, with those economies just beginning to recover--there is no reason for foreign investors to bail out of their own stock markets.

The bottom line: If you’re itching to sell something, many pros would advise selling blue-chip U.S. stocks before selling foreign holdings.

* Bonds.

As with the U.S. stock market in 1994, the bond market then was taken by surprise by the Fed’s decision to begin raising interest rates.

Not so this time. Short- and long-term market rates have been on the upswing for weeks. The one-year Treasury bill yield, for example, ended at 5.82% on Monday, up 0.40 point since mid-February.

But more so even than in the stock market, the bond market will be obsessed in coming weeks with how much tightening the Fed ultimately will decide to.

Michael Kennedy, manager of the SteinRoe Government Income fund in Chicago, figures that if investors expect the Fed will boost its benchmark short-term rate half a percentage point in all between now and summer, the one-year T-bill yield almost certainly will rise further--to 6.10% or more.

If that’s your scenario, it makes sense to wait before locking money up in shorter-term bonds.

At the same time, many pros believe that long-term yields--such as on the 30-year Treasury bond--may decline in coming months, even if shorter-term yields rise. Why? Because if the market assumes the Fed will achieve its goal of slowing the economy and restraining inflation, that’s the best possible world for long-term bonds.

Sung Won Sohn, economist at Norwest Corp. in Minneapolis, believes long-term bond yields are attractive now and will only become more so if they rise with a Fed tightening move.

But there is a wild card here, which is the dollar. It could get stronger if higher short-term yields attract more foreign capital here. That, in turn, would help make long-term bonds more appealing to foreign buyers as well.

If the surprise is that the dollar begins to weaken, however, the bond market could be in trouble. The reason: A declining dollar would erode the value of foreigners’ huge U.S. bond holdings, giving them a good reason to sell, rather than buy more.

Short-term accounts:

One constituency is a sure winner with a tighter Fed: If you own a money market fund, or have bank CDs rolling over, you should begin to earn higher yields in the weeks ahead.

How fast CD yields rise will depend on how fast banks decide to go along with higher Fed rates. Some will react faster than others.

With money market funds, on the other hand, a Fed rate increase should flow through very quickly, said Peter Crane, managing editor of IBC’s Money Fund Report in Holliston, Mass.

The average yield on taxable money funds, stuck at about 4.8% for the last year, could rise to about 5% within a few weeks if the Fed boosts the federal funds rate a quarter-point today, Crane said.

Of course, even 5% isn’t much of a return after taxes and inflation. And for that reason, many investment advisors caution that however good it feels to earn more in “cash,” such short-term accounts should only be parking spaces while you’re hunting for attractive long-term investments for your money--beaten-down stocks, for example, or higher-yielding long-term bonds.

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A Not-Unexpected Rate Hike

Unlike in 1994, when short-term market interest rates--and stock prices--seemed oblivious to the chances of tighter credit until the Fed actually did the deed, this time around market rates and stocks are anticipating the Fed.

Market Yields Have Risen

Weekly yields and latest:

Monday’s 10 year T-note yield: 6.70%

1-year T-note yield: 5.82%

3-month T-bill yield: 5.38%*

...and Stocks Have Pulled Back

Nasdaq composite stock index, weekly closes and latest:

Monday’s close: 1,242.64

Source: Bloomberg News