The Best of all Possible Worlds!

Peter Boockvar of Miller Tabak writes this morn that "Ahead of the 2 day FOMC meeting beginning tomorrow, the bond market has
basically taken out any chance of a 1st half rate cut. Through year
end, there is about a 60% chance that the Fed cuts once to 5%."

That makes today a good time to consider this question: Which is better for stocks, falling rates, rising rates, or steady rates?

The answer, according to the Bulls quoted in the popular press, is all three:

As central-bank rate setters prepare for their first meeting of the year this week, investors increasingly are resigned to a longer pause in rate moves than previously expected.

Yet it might be that it is the pause that refreshes. In recent years, the stock market usually has performed well when the Fed declines to move up or down, as it has since last summer

Some Wall Street forecasters say the Fed could go all year without changing its rate targets, a prospect that contributed to the market’s sluggishness last week.

Such predictions run counter to many investors’ hopes for a quick rate cut, which would lower borrowing costs and encourage more consumption throughout the U.S. economy, potentially helping corporate profits and thus stocks. (emphasis added)

Was it the Fed not moving rates this Summer that led to the sharp market rally? The massive complexity of the markets are why I never like to pick just one reason for any market behavior (see Single vs. Multiple Variable Analysis in Market Forecasts for more details). However, if gun-to-the-head I had to pick just one  factor, it sure wouldn’t be the Fed on hold. The GSCI energy exposure cuts, leading to a 30% drop in crude oil, coming on top of a major technically oversold condition in June would be the shortest explanation I could give. 

But the FOMC on hold as  the primary causation of the rally?  pshaw.

The Fed pause is also recently credited with helping the greenback. CNN Money notes that "After
taking a beating last year, the dollar has steadied its course and
could be poised for a lift as expectations for the Federal Reserve to
cut rates fall by the wayside."

One of the themes we have heard relentlessly since the Fed paused was that rate cuts ere imminent. With no cuts on the horizon, that meme has morphed into the economy is strong enough not to require central bank loosening. Look for this to further morph into the net positives of rate hikes later this year: "If anything there is some risk the Fed may raise rates this year, if the current supply of relatively cheap money throughout the global financial system begins to translate into more inflation in the U.S." stated Ethan Harris , chief U.S. economist at Lehman Brothers (today’s WSJ).

So there you have it in all of its Panglossian glory: If the Fed cuts rates, its good for stocks. The current rally was caused by the FOMC going on hold. And, more rate hikes are also good for stocks. 

Voltaire’s Candide had nothing on Wall Street: "All is for the best in the best of all possible worlds."


A Long Stretch of Steady Rates
Some Say Fed Could Go All Year Without Changing
Targets – And That May Be Good for Stocks

WSJ, January 29, 2007; Page C1

Extended Fed pause hopes boost dollar
As expectations for a Fed rate cut ease, greenback
could get a lift. But gains are likely to be limited, analysts say.
Grace Wong, January 25 2007: 12:16 PM EST

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What's been said:

Discussions found on the web:
  1. Fred commented on Jan 29

    IMO, the Fed was irrelevant regarding the Summer/Fall rally. The dark side became too confident and crowded. The 4 year Fall swoon was all but “guarenteed”. We had record short interest, and high put call. Liquidity trumped everything, and the total market cap dropped, despite the ~16% returns. The least expected outcome is an even better market this year. Why? — Iraq, deficites, recession/inflation, housing freefall, dollar collapse, bird flu, terrorism, Bush, etc. The market has been thrown alot of tricky pitches, and is confidently standing close to the plate. I smell a fat pitch coming from a pitcher named Goldilocks.

  2. spencer commented on Jan 29

    Over the long run the impact of a 100 basis point move in interest rates roughly causes
    the market PE to move by roughly a 100 basis point.

    So at todays mid-teen PEs a 100 basis point PE move would cause the market to move by roughly 6% to 7%. So a 100 basis point rise in interest rates would offset about a 6%-7% rise in EPS. Conversely, a 100 basis point drop in rates would have about the same impact as a 6% to 7% rise in EPS.

  3. Gary commented on Jan 29

    Heard something on CNBC that rang a bell. One of the guest commentators stated that we are overdue for a correction. He also said it would be mild and that he would hold his positions through the correction. Just the kind of mentality that I would expect from a bull market that has gone way long and had 6 uplegs so far. This bull has lulled everyone into a serious state of complacency. When the bear does return everyone will end up holding way too long and turning what could have been a normal correction into something worse. The Fed in its infinite wisdom and desire to accomodate the politicians is going to guarantee that this secular bear will be much worse than it has to be.

  4. Fred commented on Jan 29

    Complacent? I’m not so sure…Ticker Sense has the Blogger’s poll at:

    Bullish 18.92%

    Bearish 51.35%

    Neutral 29.73

    The panties are pretty tight in the blogosphere!

  5. Estragon commented on Jan 29

    If I had to pick one variable to explain markets last year, it would be the actions of the Japanese central bank, not the fed. The selloff late last spring was coincident with the JCB’s withdrawal of quantitative easing. The rebound began in the summer when the JCB stopped and partially reversed the withdrawal.

  6. Bluzer commented on Jan 29

    Estragon’s point about the JCB juxtaposed with Fred’s “liquidity trumps everything” explains a lot. Put them together and you have a market being held together by a tsunami from the rising sun. Also explains Greenspan’s deceptive conundrum.
    So much more satifying a theory than the effete efforts of erudite wall-streeters.

    Good work guys. Take the rest of the day off.

  7. pjfny commented on Jan 29

    Barry e all,
    Keep an eye on the abx subprime index…had a big selloff friday afternoon, after the rumors of bac and countrywide…also 16 small and medium size subprime lenders have closed since dec2006…is this the beginning of the riskaversion trade or another false signal?

  8. S commented on Jan 29

    Fred smells something coming from Goldilocks? Perhaps she doesn’t love us enough to wear her her anti-flatulence underwear. Bad girls so want to emulate Britney.

  9. Gary commented on Jan 29

    Complacent VIX at multidecade lows.

  10. Gary commented on Jan 29

    Everyone seems to be on the side that liquidity trumps everything. Wasn’t this tried in the 70’s and failed? Liquidity eventually equates to inflation. When everyones thinking the same thing usually nobodys thinking.

  11. jjj commented on Jan 29

    last time i heard or saw pshaw was in 6th grade class at corpus christi school mineola long mary consolata,may she rest in peace ,would teach about exclamatory sentences and pshaw was one of her favorite exclamations…..circa 1962….she also taught me how to diagram a sentence which is seemingly a lost art.Hooray for this blog!!………..jjj

  12. lurker commented on Jan 29

    Modern Voltaire equivalent:

    In my Candide opinion.

  13. Barry Ritholtz commented on Jan 29


    I am not sure that a poll of 50 bloggers accurately portrays sentiment out there.

    For example, The does a sentiment survey every week. Here’s what Ed-in-Chief Dave Morrow wrote today:

    “There’s nothing but bull skies for participants in the RealMoney Barometer survey.

    For the 16th week in a row, the bulls carried the sentiment mantle. Of the 2,078 people who took the survey, 901, or 43%, see the market rising this week.
    “Neutral” was again a popular choice, pulling down 35%, or 737 votes.

    Bearish sentiment came in at 21%, or 440 votes.”

    Bulls All the Way in Poll
    By David Morrow
    Editor in Chief
    1/29/2007 1:38 PM EST

  14. Fred commented on Jan 29

    I imagine that a poll of your readers here would be much closer to the Ticker Sense poll…up to the challenge?

    BTW…see the Ticker Sense piece on “How many days since a 2% RISE?”

    Food for thought….and good healthy debate.

  15. Jason C commented on Jan 30

    Regarding you link to the Bloomberg Story about rising UK house prices I think your point about the UK being an island and hence running out of space to build new homes as opposed to the US is completely irrelevant. I think there are more fundamental differences than simply geography. First, mortgages offered in the UK include “Self-Cert;” where the customer self-certifies his income. This leads to first time buyers paying inflated prices and keeping the market afloat. Second, the last 10 years has seen the most stable and historically low interest rates ever in the UK. Third, they are finally beginning to build higher condo towers in London and relax what were difficult planning laws. Your comparison would have been better suited to maybe Hong Kong, but then again look at what happened to prices there a few years ago, even with constrained space…

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