Fed Is No Wall St. Tool
The weakening U.S. economy, worsening trade deficit and lower interest rates should be pulling down the value of the dollar, but aren’t. The stock market should take heart from three rapid interest rate cuts and reverse its slide, but it hasn’t. Clearly, foreign investors--who would still rather put their savings into the U.S. economy than anywhere else--have greater confidence in Fed Chairman Alan Greenspan’s ability to reignite growth than do domestic ones. Maybe stock market investors need to adjust their expectations.
If market mavens had their way, the dollar would be heading south. After all, why would anyone want to buy or hold dollars or dollar-denominated securities when the Nasdaq stock market has shed 60% of its value, the U.S. economy is sputtering, the trade deficit keeps growing and interest rates are coming down? But on the contrary, the greenback is very much in demand, selling at close to a 22-month high against the Japanese yen and buying more euros--the common currency of 12 European Union countries--than it did three months ago. Ditto on its relation to Canadian and Australian dollars. Those investors obviously feel greater confidence in the Fed and its handling of the economic slowdown than they do in Japan’s lame-duck Prime Minister Yoshiro Mori or the overly cautious European Central Bank.
Stock market investors’ demands for Fed action stem from their fear of declines in corporate earnings, a drumbeat of doomsday reporting and, most important, the pain of accumulated loss. Reeling from declines they hadn’t seen in years, the markets earlier this month pressured the Fed for a rate cut of at least three-quarters of a point. When the Fed did not oblige, cutting the rates by only half a point last Tuesday, the Dow Jones went into a tailspin of overreaction, dropping 433 points before regaining some of the lost ground Friday.
No one will argue that the Fed’s actions are perfect, but the Federal Reserve was right not to try to please the stock market. The economy is, indeed, in distress--although not in recession--and the Fed has responded by cutting short-term rates by 1.5 percentage points since January. It is prepared to cut more, if needed. But the stock market, while important, is not the economy. In shaping its policy, the Fed must look beyond the well-being of stockholders.
The prognosis for the U.S. economy is uncertain, but foreign investors remain confident, at least for now. The stock market might take a cue.
