New Posse Frowns upon Fed Actions

Article excerpt

Thirty years ago, bond traders and economists concerned that inflation was going to bring the economy to its knees were dubbed the bond vigilantes. This loosely connected group spoke and acted in ways to make certain that the Federal Reserve was aware of a budding inflation problem.

Last week's half-of-one-percent cut in the federal funds target rate and the discount rate brought out a new self-appointed posse to police the market.

Perversely, long term borrowing rates moved higher. In Treasury paper, the higher interest rates partly reflected a move away from the safety of Treasuries and into riskier investments. Part of the move to higher yields, however, was a clear expression from the new credit market watchdogs that inflation worries not only still exist but that the Fed's action might have made the situation worse.

The Philadelphia Federal Reserve Index report last week was considerably higher than a month ago and notably higher than expected. To the bond vigilantes, the report was solid evidence that the economy did not need lower interest rates.

Nonetheless, stocks posted one of their best weekly gains in a long time. From the close the day before the Fed meeting through the high on Friday, the Dow Jones Industrial Average gained 475 points, or 3.5 percent, for the best weekly gain since the middle of last year. The Dow and the Nasdaq Composite Index broke above some technical resistance points, which suggested the additional upside was likely. The market also rapidly returned to its pre-subprime loan problem favorites. The material, industrial and energy sectors of the S&P 500 led the advance.

That the market's exuberance weighed against the worries of the bond vigilantes begs the question of which view is correct.

The answer probably depends upon the time frame you consider, and even then, there is no definitive resolution to the debate. …