The Fed Move: Interpretations Span the Spectrum

The Fed's Open Market Committee decided, while holding short-term rates constant, to remove the official bias toward further rate increases, while including some strong language about continuing concern over inflation. Experienced Fed observers know that central bankers always maintain a posture that expresses concern about inflation. One of their missions is to convince markets that they are vigilant, since they do not want high inflation expectations to drive wage and price decisions.

The market interpretation of this was decidedly bullish for equities and also for short-term rate expectations. The punditry was, not surprisingly, split in the recommended reaction. Barry Ritholtz, as usual, has the strongest articulation of the bearish interpretation. He believes that the Fed is in a box, threatened by an incipient recession, while inflation is still out of control.

A CNBC Mark Haines interview with Stephen Wood, Ph.D., Portfolio Manager for the Russell Investment Group, provided an opportunity to consider this argument. Haines aggressively challenged Wood with language from the Fed statement. It was almost as if he had Barry's argument in his hand. Investors and traders alike should consider Wood's thoughtful reply:

We are today where the Fed said we would be last year. They wanted to decelerate the economy from the mid four percent GDP range to the mid-two’s and the data are suggesting that we are there. Employment and inflation are very much lagging indicators. The inflation data today tell us about Fed policy from nine months ago.

What we are looking for in the balance of 2007 =- 2.5% GDP range, rate of change in inflation is about where the Fed wants to be. This looks a lot like the 1994-95 mid-cycle slowdown.

This makes good sense. We try to remain open-minded about events, allowing our predictive indicators to dictate our posture. This means that a planned slowing of the economy to relieve inflationary pressures represents normal data. Investors should not be alarmed unless forward earnings projections decline significantly -- and in the current market environment, the decline would need to be very significant for fundamental investors to abandon stocks.

Some observers, including Edgar Peters, chief investment officer for PanAgora Asset Management, feel that the Fed is comfortable with what they have already slowed down to fight inflation, and that economic growth is a focus.

The wise market observer, Art Cashin of UBS Financial Services, tells us what those on the floor will be watching. He notes that several Fed speakers are on the agenda. In his comment today he writes, "It will be interesting to see if anything in their words or tone hints they think the market over-reacted."

If Art Cashin thinks that is what traders are watching, then we should be watching as well.