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The Fed's Pregnant Pause

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09/21/2006

The Federal Reserve rendered its decision on the fate of interest rates today, and the central bank decided to hold overnight interest rates steady at 5.25%. The key to the Fed's decision for the markets is always the accompanying statement. Once again Mr. Bernanke and company left the door open for further rate hikes if inflation begins rearing its ugly head.

The Fed's decision to keep its finger on the pause button came as no surprise to Wall Street, and as a result the early session gains the market enjoyed remained largely intact (although the markets did pullback from their highs of the day), after the decision and the accompanying statement hit the newswires.

Interestingly, the Fed's statement was little changed from August when it also held the line on rates. The Federal Open Market Committee (FOMC) said it expects that the current economic slowdown will continue to reduce inflationary pressures.

"The moderation in economic growth appears to be continuing, partly reflecting a cooling of the housing market," the statement said. "Inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand." What the Fed basically is saying is that it remains on alert for higher-than-expected inflation.

The one dissenting voice within the FOMC came from Richmond Fed President Jeffrey Lacker, who maintained his opinion from August by voting to raise interest rates. One thing that this lack of unanimity by the Fed tells me is that the FOMC is now confronted with a tricky economic environment. The Fed is trying to balance slowing growth against the omnipresent risks of inflation.

The 800-pound gorilla in the Fed's boardroom is housing -- the factor that has me the most worried about the future of the economy. The slowdown in the housing sector could restrain consumer spending. Right now, nobody really is certain how much of a crimp a bursting of the housing bubble will have on this economy. That's why I'm describing today's Fed decision as a "pregnant pause." It might take a few months, but we could start to see the housing bubble cause a substantial slowdown in the economy.

The next FOMC meeting is on Oct. 24, when I expect its most important decision of the year. If rates remain on hold at that meeting, then there is a good chance the Fed will keep rates steady for awhile. Historically, completion of a rate-tightening cycle causes the Fed to maintain current rates for at least a few months. A multi-month pause on interest rates could prove to be the catalyst for new all-time highs on the major averages.

As always, the fate of the markets remains uncertain. And as always, the key to managing your money efficiently is to have a plan in place that is able to capitalize on the trends in the market, even if the Fed's direction and the fate of interest rates remain up in the ether.

To find out how the Successful Investing trend-following strategies can give you the edge regardless of what the Fed does, click here.

A COMMODITIES CRUMBLE

Amid the swirl and conflicting opinion on inflation and its potentially caustic effect on the economy, few on Wall Street appeared to have noticed the big decline in commodities prices during the last six weeks. In fact, one glance at a price chart of the PowerShares DB Commodities Index Tracking Fund shows us just how sharply commodities prices have fallen of late.

Now, while much of this decline can be attributed to the recent pullback in crude oil prices, there also is a large portion of this index that reflects a big drop in industrial commodities.

I bring this trend in commodities to your attention for two reasons. First, it's important to know some of the driving factors that contribute to monetary policy and that can have a profound effect on the equity and bond markets. Second, whenever I see a steep drop in an index, bells start going off in my head that alert me to a potential profit opportunity in my ETF Trader service.

And while I am not ready to declare myself on board with a future turnaround in the commodities market, it is important to recognize trends and their potential reversal points when your goals are short-term profit maximization. It's these turnaround candidates that often give investors big returns. However, it requires a skilled analyst to know the difference between a comeback and a laggard.

That kind of skilled analysis is what my ETF Trader advisory service is all about.

Want to learn more about how to profit from acute market trends? Click here.

THE WISDOM OF DOUBT

"Doubt is not a pleasant condition, but certainty is absurd."
—Voltaire

I know that sometimes the doubt we harbor surrounding the direction of stocks and what to do with our money is, as Voltaire says, not a "pleasant condition." But the alternative to those doubts is complete certainty, and as the great French writer/philosopher points out, that is indeed "absurd."

Wisdom about money, investing and life can be found anywhere. If you have a good quote you'd like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars, or anything else.

Click here to Ask Doug


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