Has Ben Bernanke become too worried about the stock market?
A surprising surge in December durable good orders raised fresh concerns Tuesday that the Federal Reserve chairman's bias towards cutting interest rates is more a reaction to pressure from Wall Street than economic fundamentals.
And even with the markets betting on another rate cutwhen the central bank concludes two days of meetings Wednesday, some economists are questioning whether a follow up to last week's surprise three-quarter point cut is even necessary.
“They clearly cut rates because of the stock market.” says Robert Brusca, chief economists at Fact & Opinion Economics, “I do think the Fed has a made a mistake in placing too much emphasis on the market.”
Nevertheless, Brusca expects another rate cut. He says a quarter of a percentage point -- not half a percentage point--is now more likely.
Ram Bhagavtula, managing director at the hedge fund Combinatorics Capital , says the Fed moved up its rate cut a week and thus expects no change in the federal funds rate – now at 3.5 percent -- or the accompanying policy statement.
Bhagavatula says he understood the Fed’s decision to cut rates in September, but “every meeting has been a surprise “ since then. ” I have no clue what or why they do it, “ he says.
Both Bhagavatula and Brusca think the Fed is taking its eye off of inflation, when few if any economic indicators are pointing to recession.
“Monetary policy is a very blunt tool,” says Bhagavatula. “You use it to manage inflation not the real economy.”
Whither The Economy
Though December’s spike in the jobless rate triggered recession alarms, subsequent weekly data have not confirmed any trend in labor market weakness. (The January unemployment rate is released Friday and the consensus forecast if for no change in the 5.0 percent rate.)
Overall economic indicators, at best, have been mixed, without any defined downturn in consumer spending. A modest decline in the Conference Board’s consume confidence index – following an increase in the University of Michigan sentiment survey -- was accompanied by an improvement in other indices measuring perceptions about the job market.
“The Fed has lost its way.” says Brusca. “The Fed has to make up its mind about what it thinks and what's going to happen.”
Brusca adds that the Fed “ needs to take some of that positive guidance off the table” in its statement Wednesday, partly because of the broad-based strength suggested by the durable goods report.
Data released Tuesday showed orders increased 5.2 % overall and 2.9% excluding the volatile transportation sector. In addition, capital goods – considered a good barometer of business spending -- posted a 4.4 percent increase.
Fourth-quarter GDP data is due out Wednesday ahead of the Fed meeting and comes at a time when economists are raising their forecasts – Briefing.com’s latest consensus figure, for instance, is an annualized rate of 1.2 percent versus less than 0.8 percent earlier this month. The economy grew at almost a 5-percent clip in the third quarter, following a weak first half showing.
In some quarters, the importance and traditional economic indicators is being undercut by the negative – and largely immeasurable – effects of the credit crunch, which has hurt Wall Street as much or more than Main Street, prompting large write downs because of devalued subprime loans.
Some economists say that great unknown warrants an aggressive Fed and that the Fed is indeed compensating for that.
Crunching The Numbers
“The Fed “is doing the right thing,” PIMCO portfolio manager Paul McCulley told CNBC, and is in "full-blown risk management,” even if it is not forecasting a recession. Risk management is "all about talking out insurance,” McCulley says more rate cuts – he’s guessing half a percentage point Wednesday – are appropriate.
“Housing in recession,” echoed Gary Schilling, president of A Gary Shilling. “Other markets are becoming unglued.”
For all of the doom and gloom about the credit crunch, it is unclear how much damage it has created other than losses and writedowns at financial powerhouses like Citigroup and Merrill Lynch and the near failure of Countrywide Financial .
Brusca, Bhagavatula and others say some of the Fed’s other liquidity measures have been effective in dealing with the credit crunch by restoring interest-rate spreads to healthier levels and spreading the risk.
Scott Rothbort, president of Lakeview Asset Management, disagrees, adding that the Fed needs to “get the yield curve to a point where people want to lend money again.”
Rothbort, who is also a professor at Seton Hall University's Stillman School of Business, is among those who say the Fed remains behind the curve in cutting rates and that the FOMC needs to cut more – anywhere between a full percentage point to one and a half percentage points.
“I think they're looking at the economic data but slowly arriving at the conclusion that Wall Street is a lot smarter that it's given credit for,” says Rothbort.
Wrong Either Way
In the end, what the Fed should do and elects to do are two very different things. What’s more critics of both persuasions and supporters alike say the market is likely to be disappointed by the Fed’s decision Wednesday.
Both Interest rate doves – those who want a cut of at least half a percentage point – and inflation hawks – those who would like to see no change in policy and/or a change in language indicating the Fed may be nearing the end of its easing cycle – say the Fed has little credibility with the markets. As a result, it is very vulnerable to second guessing and negative reactions in the market.
Bhagavatula says the Fed has been “introducing more volatility into the economy.”
Rothbort thinks half a percentage point is warranted but thinks a quarter-point cut is a more likely outcome, which will only "disappoint and exacerbate the problem.”