Wednesday, June 27, 2007

An Orderly Decline

As investors await the FOMC’s rate decision, the focus of many will be on whether a rate cut is in the near future. However important such information is, the focus on these pages will be in the area of the balancing act the Fed must play between weak domestic growth, strong global growth, and fat tails and other uncertainties that financial innovation has wrought.

As the two month chart to your left shows, the equity markets seem to have settled into an orderly decline over the past month (note the tighter fit among the four major market cap sectors – large, mid, small, and micro). Its continued progress is dependent on the ability of the Fed to manage the delicate balance.

Investment Strategy Implicatins

It should be apparent by now that central banks around the world are seeking to deflate the liquidity bubble without bursting it. Call it a global soft landing, the aggregate concerns are centered on demand push inflation emanating from non US growth. The Fed has to strike the delicate balance between weak domestic demand and rising cost pressures from global growth, all the while being mindful of the risks presented by financial innovation. Based on the equity market’s behavior these past two months, investors seem comfortable with the economic environment. The consequences of failure will, however, produce a far more dramatic decline than most investors are prepared for.

No comments: