THE DAY AHEAD: Fed can''t save investors from themselves

4 min read

With any luck, investors pleading for a massive cut in short-term interest rates Tuesday will be terribly disappointed by the Fed this week. No matter what the central bank does this week, it's going to take improved corporate sales and earnings to spark any meaningful recovery.

You can count on a wide range of predictions and suggestions from pundits Monday as to just how low the Federal Reserve Board's Open Market Committee should take down interest rates. Some will say a quarter-point. Others will demand a half-point or more.

I'm hoping for no change at all.

Investors will be taking positions in stocks and bonds Monday, betting on or hedging against a major reduction in lending rates. Most analysts are confident the Fed will knock off at least half a point, all but erasing the six rate increases Chairman Alan Greenspan ordered through the frantic bull market in 1999 and 2000.

The unfettered collapse of both the Dow Jones industrial average, below 10,000 for the first time in more than a year, and the Nasdaq composite, off more than 60 percent in this same period, has investors begging for mercy. They hope the Fed will bring this salvation.

This mentality is quite a departure from the go-go 90's when technology stocks rocketed through the stratosphere, apparently oblivious to the rapid succession of rate increases. In fact, the Nasdaq continued to grow at an astounding clip even after Greenspan & Co. raised rates 1.75 percent in a scant 18 months.

At the time, Greenspan said the rate hikes were necessary to curb "irrational exuberance" and the threat of inflation as unemployment became a non-issue and prices edged higher.

Greenspan, who received far too much credit for "overseeing" the greatest bull market in U.S. history in the past 10 years, is renowned for his notoriously circumspect approach to the nation's monetary policy.

Some analysts believe he strayed from this conservation mindset when he jacked up rates and now that the economy is coming back down to earth, he's in danger of making the same mistake, albeit in the other direction, this time.

It takes almost a year for the U.S. economy to completely feel the impact of even a quarter-point rate hike or reduction.

"Trigger Finger" Al cut short-term rates by a full point in January and hinted that he might cut again before Tuesday's meeting. This marked the first time since 1982 the Fed has cut rates twice in the same month.

So, the economy won't feel the impact of January's cuts until the fourth quarter of this year at the earliest. It has yet to absorb the increases implemented in early 2000. Truth is, there's no way to accurately gauge where the economy is in respect to interest rates.

On Friday, the Labor Department reported the Producer Price Index, which measures wholesale selling prices, moved up 0.1 percent in February, inline with analysts' estimates. Taking out price increases for food and skyrocketing energy prices, the core index fell 0.3 percent—their steepest decline since mid-1993.

Meanwhile, housing starts fell a modest 0.4 percent in February—not as much as most economists had predicted—to a decent clip of 1.647 million units at a seasonally adjusted annual rate.

And the University of Michigan's consumer confidence report checked in at 91.8 in March, slightly higher than expected and better than the 90.6 level registered in February.

"The PPI is a friendly number, but the market is not weighing it too heavily because there are much bigger issues at work in the market," including warnings about earnings from corporations, said Tony Richards, managing director at Brinson Partners.

The Dow, the S&P 500 and the Nasdaq have all tanked of late and investor confidence is shot.

Instead of giving investors what they think they need, Greenspan and the Fed should take the conservative route and not adjust rates at all. Let these investors who got themselves into this mess, figure it out for themselves.

The Fed's responsibility is to use the considerable clout of interest rates to help keep the economy growing at a steady but sensible rate.

It's not the Fed's responsibility to adjust rates in an effort to ignite or suppress the equity market. The equity market reflects the economy, not the other way around.

Pundits are all over the board with their predictions. Some are holding out hope for an optimistic reduction of 0.75 percent. Others think the Fed will stand pat.

"The dynamics are that if the Fed disappoints next week, then the better sentiment numbers will quickly reverse," said Richard Gilhooly, fixed-income market strategist at BNP Paribas Corp. "At this point the market wants at least 75 basis points on Tuesday."

That's precisely the type of thinking that got investors into this position in the first place. Now they want Grandpa Al to kiss their boo-boo and make it all better.

Until earnings improve, as most companies and analysts believe they will be the fourth quarter, this market's not going anywhere, with or without an interest-rate cut. Instead of giving investors an opportunity to refinance their homes and sell into a rally, Greenspan should make a statement by not doing a damn thing this time around.

If the economy further deteriorates—though recent economic data suggests the opposite—the Fed can always adjust rates at any time. It's not as if Tuesday is the only window of opportunity.

Until then, Greenspan should use his bully pulpit to advise investors against irrational panicking.