Big Ben Utter, Markets Shudder

The Federal Reserve has increased rates by a quarter of a percent 16 times including their May increase without a major market drop, but one would think that the likely quarter point increase at the end of this month will be the straw that breaks the veritable camel’s (err bull’s) back.  Since that May 10th meeting the Federal Open Market Committee has become a ‘federal open mouth committee, as termed by one of our favorite economists, Ed Yardeni.  The mixed signals have rattled markets of all stripes, from stocks, to bonds, to commodities. 

The leader of the choir, Ben Bernanke has seemingly about-faced amidst the public eye.  Back on April 27, he told a Congressional committee that the Fed might pause even if inflation continued to rise: “The FOMC will continue to monitor the incoming data closely to assess the prospects for both growth and inflation.  In particular, even if in the Committee’s judgment the risks to its objectives are not entirely balanced, at some point in the future the Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook.”

This week, inflation dove turned inflation hawk, Ben said that even if the economy slows, the Fed would tighten to keep inflation from rising: “Therefore, the Committee will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained.”  Has Mr. Bernanke suddenly changed course or is all this talk simply ‘jawboning’ – the use of public warnings as a substitute for actual rate increase.  In some cases it can be almost as powerful as the actual rate increase.

As Mr. Yardeni points out, it took 16 rate hikes to take the froth out of housing.  Just the anticipation of number 17 is taking the froth out of commodities and stocks.  It also appears that other central banks are becoming leery of raising their benchmark rates too far.  The ECB raised its official rate yesterday by 25 basis point, not 50 as some feared.  The Bank of England paused again at this week’s meeting leaving the official rate unchanged at 4.5% for the tenth month in a row.Australia’s central bank paused after raising the official rate to 5.75% last month for the first time in 14 months.  And it is increasingly likely that the Bank of Japan will vote to maintain their official rate at zero given the strength of the yen in recent weeks and the plunge in stock prices in recent days.

In the 21 trading days that followed the Fed Meeting of April 10th, the S&P 500 has declined 7.6%.  The NASDAQ 100 (largely technology stocks) declined by just under 9%.  Copper, gold, and oil have fallen 16%, 14% and 5.8% respectively.  The CRB index of commodities as a whole is down 7.5%.  Each of these markets is rebounding today, but these retreats are significant.  While the retreats were broad-based, the more speculative asset classes were hit the worst.

Emerging markets have been soundly thrashed as investors worried that rising rates would dry up investments in developing countries.  The MSCI Emerging Market Index is down 24% since May 10th.  Here at home, stocks of industrial, chemical, oil, technology, and basic materials have been worst hit.  Investors who feared a slowing economy would result from excessive Fed tightening aggressively sold the stocks of these companies.

Has anything really changed?  We may not know the true mind of Big Ben for several more Fed meetings, but we do know that he HAS to establish himself as an inflation fighter.  This last rout of stock and commodity markets strongly indicates that investors are paying attention and that he has earned their respect if not yet their confidence.  The Fed will likely tighten again this month, and maybe next.  But it is evident that a pause is coming in the near future as signs continue to impress that the global economy is slowing and demand across the board is retreating.  We’ll keep watching and listening for bears.