As rallies go, yesterday’s pop in equity and bond prices was impressive. Shortly after the Fed’s FOMC announcement hit the street, which confirmed that interest rates would remain unchanged, buyers took control. In the final two hours of yesterday’s trading session, the S&P 500 jumped 1.7% while the bulls pushed the yield on the 10-year Treasury down to 4.52%, the lowest in more than a week.
But rather than seeing yesterday as an end, the session was the start of a new gambit on predicting the next phase of the business cycle, which increasingly looks long in the tooth. Consider yesterday’s comments from Gail Fosler, chief economist of The Conference Board. Although the economy continues growing and still looks healthy, there are warning signs to consider, especially in connection with inflation. “The forces driving corporate profitability will likely become more adverse as we get further into 2007,” Fosler said. “Slowing productivity and rising costs do not bode well for the future.”
Indeed. But investors yesterday had other ideas. For bond traders, the source of buying optimism was the Fed’s formal recognition that the economy is slowing. In the FOMC statement, the central bank announced: “Recent indicators have been mixed and the adjustment in the housing sector is ongoing.” In addition, the bond bulls focused on the absence of the “additional firming” language in yesterday’s press release regarding monetary policy–a phrase that was present in the previous statement.
But did the buyers overlook the rest of the FOMC statement? For instance, this passage doesn’t inspire confidence when it comes to owning bonds: “Recent readings on core inflation have been somewhat elevated. Although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures. In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected.”
Interest rates are unchanged, and the Fed’s worried about rising core inflation. Ok, we can take a hint.
But for now, there’s enough doubt about the future to justify almost any short term move in the markets. As the Fed advised, “incoming information” will determine what comes next. Nonetheless, by our reckoning, the central bank is preparing the market for what may be a new round of tightening if inflationary momentum continues. Mr. Market, however, chose to place his focus elsewhere. So be it. Optimism usually wins out when there’s a choice. Most of the time, the optimism’s well placed. Will it be again? Or was yesterday’s buying another case of irrational exuberance?

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    Maybe it was equally a technical buy yesterday afternoon after Fed announcement . Most indices were hovering just above 50dma , having gained that ground over last week . Better to buy above same than below eh? Are the masses wrong ? Bill

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