The Market – March 21, 2007, Day of Disbelief

March 22nd, 2007

Today’s market action goes beyond belief and expected reality.  The two percent increase across all indices simply because of the deletion of the words “additional firming” without a thoughtful analysis of the meaning behind the Fed’s statement, screams ignorance as the bulls and bargain hunters shoot first and think second.  The Fed changed its typical language, dropping the focus on further rate hikes. The new language reads: “Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” The old language reads: “The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

Perhaps the Fed doesn’t know what they are doing (unlikely), but let’s consider the change in the Fed policy statement relative to the data since the last meeting.  In the face of increasing inflationary pressures, further signs of economic deterioration, and housing malaise, the Fed decided to remove their “additional firming” position.  If the Fed is develping a more dovish stance, as the market seemed to believe today, then this Fed may not be very smart.  But I don’t think the Fed’s intention today was to suggest that it is more dovish (much to the market’s chagrin).  Rather, I think the Fed’s intention was to show that its concern is no longer simply about inflationary pressures, but now includes increasing concerns over the potential for macroeconomic systemic shock risks (such as subprime fallout, continued housing malaise, potential manufacturing sector recession, etc.) and a weaker than expected economy.  The Fed is basically saying, “we do not believe inflation is the only risk anymore, as such we are removing the ‘additional firming’ position and replacing it with ‘we will do whatever is necessary to help this economy if it weakens more than expected, or suffers a sudden systemic shock, or inflationary pressures increase.”

I have to wonder if during this frenzied bullish up-move today, did no one step back and think ‘hm, the Fed really talked a lot today about increasing inflationary pressures… maybe they aren’t trying to suggest they have a dovish position.”  The Fed even said, “Recent readings on core inflation have been somewhat elevated.” That’s opposed to January’s statement, which read: “Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time.”  Today’s Fed was not a dovish Fed; it was a Fed proactively positioning itself for a quick response to the three economic risks noted above.  Remember, we are dealing with Helicopter Ben, whom likes to remind the market of the Fed’s multiple tools available to sustain stable economic growth.  Hopefully the market will come to its senses, and all of the fast money that greedily poured into the market today will somehow grow a brain and consider that the Fed may be more concerned about the economy than it would like to let on.

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