Interest and inflation

Michael Pollak mpollak at
Sun Apr 16 03:31:38 PDT 2000

The recent stock swoon casts several interesting lights on the discussion we've been having on the Fed and interest rates, supporting both sides. OT1H, the market seems clearly to have plunged because it was afraid of Fed hikes to come, arguing against those that think interest rate hikes can have no effect on it. OT2H, the trigger was a report of accelerating inflation, the very existence of which supports Enrique's oft-repeated point that five quarter point hikes have had zero effect so far -- both inflation and growth are as high or higher as they were when the Fed started tightening. OT3H, you don't have to accept that money market funds are a shadow unregulated banking system that is drastically undermining the Fed's influence to come to that conclusion -- several old-fashioned establishment interest rate hawks both on the Fed and in the business press have been saying that same thing all along simply on the basis that the NAIRU hasn't changed as much as people think, and that inflation was low because of conjunctural factors (low commodity prices, low economic activity in Asia and Europe, low oil prices, strong dollar) that are now changed or changing.

But I think the plunge also provides two provisionals answer to Enrique's question of "How can 7% interest rates affect the stock market when people expect 20% returns?" The first is that people do expect interest rate hikes to slow economy as a whole, at least the old economy most of us live and work in -- and I think they have some dim idea that, if times are not as good for normal companies and their employees, neither will have as much money left over to spend on e-stuff. Of course, an intelligent investor would say Hell, why should that matter, they don't buy enough for us to make a profit now, we'll just lose less. But as Enrique has pointed out several times, the average investor isn't quite that smart sophisticated -- side-by-side with his belief in "momentum," he actually believes these companies are doing something.

And the second mechanism is simply momentum in reverse: because every investor knows that investors in general think interest rate hikes lead to market falls, they know they mark the time to sell. And the psychology of 20% gains that was built by huge upward swings can be reversed by huge reversals just as fast as it was built.

In short, it's possible to maintain that interest rates still have their bite *and* that the last five quarter point increases did nothing.


__________________________________________________________________________ Michael Pollak................New York City..............mpollak at

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