Wednesday, October 31, 2007

Whose Fed Is It Anyway?

The 180 the Fed sprung on everyone last month needs to be rectified and clarified with today’s rate decision and subsequent minutes by sending a clear and convincing signal that this Fed and not Wall Street’s bankers is calling the shots based on the needs of the economy and not the needs of bankers who made poor business decisions. The key word in the previous sentence is convincing for everyone knows what were the stated reasons for last month’s reversal. However, as with the claims of Patriots coach Belichick that they are not running up the score, the rhetoric doesn’t seem to match the actions.

Investment Strategy Implications

History demonstrates that rate cuts result in increased asset values. In the multi decade, mega trend of the Debt Supercycle (see prior commentaries) with the tipping point of too much debt still in the future plus the powerfully positive effects of globalization, the productivity and growth benefits from advances in information and communications technologies, and the embracing of market economies in nearly all segments of the world, rate cuts will produce higher asset values.

Moreover, given realistic expectations that a US slowdown will result in only a modest decline in global growth, a sustained decline in the cost of capital is yet another reason why rate cuts will result in higher asset values in such an environment. The risks are, however, on both the inflationary and central bank credibility side.

With global growth as strong as it is, high levels of liquidity, high levels of growth of liquidity (see previous comments re MZM), strong balance sheets (corporate and nation states), and reasonable valuations the investment strategy decision comes down to the expansion and contraction of the asset allocation mix (cyclical/tactical calls) and the sector and style picks for what increasingly looks like an emerging inflationary global environment.

Improvisation may work well on the entertainment stage. But in the high stakes game of global finance and the world economy, the risks of sending the wrong message via a decision process that is confused, if not conflicted, are great. Knowing whose Fed it is would help.

Have a fun Halloween.

No comments: