There is a bit of an inconsistency in the idea that risk assets such as corporate equities can gain now that the Fed has signaled through three newspapers (the Washington Post yesterday, and the Financial Times and the Wall Street Journal today) that the odds of near-term rate hikes are lower than the market thinks, mainly because the rate hikes were being seen positively as a way to support the dollar and reduce the surge in commodity prices. A lax Fed would of course weaken the dollar and spark another rally in commodity prices.
While there is definitely inconsistency between gains in risk assets and the idea of a delay in the Fed's inflation fight, it is mostly an inconsistency for the short-run, mainly because the battle against inflation is now on. In other words, there is a rationale to rallying risk assets on the idea that inflation will be tackled and the economic outlook improved despite the short-run inconsistency prompted by signals about a delay in rate hikes (relative to expectations), since the market must of course discount that battle and its subsequent impact ahead of time. In the absence of a rate hike, whether in the near-term investors can cling to the idea that the Fed will be successful in containing influence will depend heavily upon the performance of commodity prices.
(Discussing the likelihood that the Fed will raise interest rates this year, with Joseph LaVorgna, Deutsche Bank; Julie Coronado, Barclays Capital and CNBC's Rick Santelli)
For now, the Fed's jawboning is enough because it represents a shift no matter how you slice it. After all, the Fed actually cut rates at its last meeting in April, which of course means that the Fed's tough talk represents a major shift in policy. Action will nonetheless eventually be needed and as I said it has already started, with the indication of an inclination to stop cutting rates and the jawboning. The next point of action is next week's FOMC meeting, where there of course must be no cut AND language that is a little tougher on inflation. If inflation expectations move higher, a more definitive shift toward a hike will be necessary.
For now, a big gain in share prices, say to the 200-day moving average for the S&P 500, on the idea that inflation will be licked would be a mistake in my view, because for starters a rate hike (in the context of the credit story) can't be delivered now and if it were it would be damaging to the economy, and because we can't be sure that the G-7 can control inflation given the fact that global forces have become so dominant.
A strong basis for a rally, in my view, would be a further talking up of the dollar before, at, and after the July 7-9, G-7 meeting, and an increase in OPEC supply. If the dollar steadies and oil falls on their own, that would also do the trick. Big enough moves in these areas would push the S&P back toward its 200-day moving average. At that point Treasuries would likely be at their lows for the year.
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Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the co-author of the just-revised "The Money Market" and "The Strategic Bond Investor."