The Pause That Refreshes

Did you hear it? That whooshing sound was a loud sigh of relief when, on Tuesday, August 8, the Federal Reserve released its decision on interest rates. After 17 consecutive rate hikes, the FOMC held fast.

The following is the text of their decision.

"The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4%.

Economic growth has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.

Readings on core inflation have been elevated in recent months, and the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

Nonetheless, the Committee judges that some inflation risks remain. 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.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Jack Guynn; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Kevin M. Warsh; and Janet L. Yellen. Voting against was Jeffrey M. Lacker, who preferred an increase of 25 basis points in the federal funds rate target at this meeting."

This was the news the market had awaited with great anticipation and the reaction was, by and large, a big yawn! By market's close did the indices roar to new highs? Decidedly not! The day ended with the Dow off 4.1%, the S&P off 3.4%, and the NASDAQ down 5.6%. The major indices were all down for the week (The Wall Street Journal, August 14, 2006).

What we hope for is a "Goldilocks" scenario….an economy that has neither too soft or too hard a landing, but just right…not too much growth too quickly or too little too slowly. If the Fed's monetary policy has sufficiently kept inflation at bay, then we can look forward to interest rates remaining at their current level and consistent growth at a measured pace.

Economics 101…. if demand doesn't outpace supply and labor costs don't escalate then corporate earnings should provide reasonable stock valuations. The key is the FOMC's statement that they will look to "incoming information" regarding inflationary moves, but my crystal ball is a bit cloudy at this writing. However, as I have predicted in the past, I suspect after this pause we will see another quarter-point rate rise in our future.