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Rates will rise, even if Bernanke says nothing
That's what I think the financial markets will conclude from new Fed Boss Bernanke's appearances this week before Congress. Plus five transportation stocks to look at.
By Jim Jubak
Sometimes context is everything.
I've been sure that new Federal Reserve chairman Ben Bernanke will try to follow former chairman Alan Greenspan by saying very little at great length when he gives his first public testimony to the House of Representatives Wednesday and the Senate today. He knows that investors will pick apart every word looking for clues to the Fed's next moves on inflation, economic growth and interest rates. And he certainly doesn't want to begin his tenure in the Fed's hot seat by rocking the financial markets.
Ben Bernanke
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But as well as Bernanke succeeded Wednesday and probably will today, circumstances may make it impossible not to affect the markets. With his testimony sandwiched between a better-than-expected report on January retail sales (which came out on Tuesday) and a first revision to fourth quarter GDP growth (due on Feb. 28) that could leave the economy looking stronger than expected, the financial markets are looking for -- and finding -- confirmation for the belief that the Fed is likely to raise interest rates further than expected in Bernanke's testimony -- no matter how carefully he speaks.
Judging from recent strength we've seen in the U.S. dollar, which goes up against other currencies when traders think U.S. interest rates are likely to go up, the financial markets are starting to believe that the Fed's Federal Open Market Committee won't be finished raising interest rates after a final hike at its March 27-28 meeting. (The FOMC is the Fed's interest-rate setting body.) The economy looks strong enough, an emerging majority is arguing, and inflation at the producer level has picked up enough that the Fed will keep marching interest rates higher.
That belief rests on some mighty thin reeds, in my opinion.
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First, retail sales were stronger in January, climbing by 2.3%, way above the expected 0.9% growth projected by economists. That number looked even stronger than it was because December retail sales had grown an anemic 0.4% in December. The December number had revived fears that the Federal Reserve's interest rate increases had finally started to slow consumer spending. But January's jump brought the year-to-year increase in retail sales to near 10% and pretty much quashed fears of any consumer slowdown.
Second, there's a good chance that the advance read on the economy's growth in the fourth quarter of 2005, which showed GDP growing by just 1.1%, will get revised upward when the second take on GDP growth for the quarter is announced on Feb. 28. A significant positive revision that takes growth back above 2% isn't out of the question since the first read on the economy's growth rate is based on very, very incomplete data on things like exports and imports. Even if the revision isn't large or even positive at all, the early numbers on economic growth in the first quarter of 2006 already make the bad news from the fourth quarter seem like ancient history to many investors and traders. Early, pre-preliminary reports on the first quarter of 2006 suggest that economic growth has rebounded from any end of the year slump.
I'm extremely dubious that there's a meaningful pattern in this data -- these statistics are too volatile over such short periods of time to prove that a trend is in place. However, that doesn't mean the financial markets won't draw conclusions -- and act on them -- anyway. That's especially likely since the data can be made to fit the financial market's preferred theory about the new Fed chairman. Bernanke, the thinking goes on Wall Street, will be out to earn his spurs as an inflation fighter as quickly as he can. What better way than by raising interest rates further than Greenspan might have.
The markets on Wednesday heard his House testimony that economic growth is "stable" or "satisfactory" as confirmation that he intends to raise interest rates in March and in May, one more time than the consensus opinion thought likely back in December. If they hear him say today -- more strongly than he did on Wednesday -- that inflation needs to be watched or hourly wages are pressing higher, they'll see that as more confirmation of even more interest rate increases ahead.
That may produce a sell-off in bonds (since the price of existing bonds goes down when interest rates go up) but a stock market that holds its own or even rallies. Reason: Investors will have decided the economy is growing slightly faster than expected. (At the end of last year, in fact, many economists were predicting a slight slowdown for the second half of 2006.)
The calendar will help keep this belief alive for a while, because, remember, the FOMC doesn't meet again until the end of March. So traders and speculators won't have anything concrete to contradict their trading strategies until the meeting. If then. Since only an interest rate increase -- or not -- at the May 10 meeting will really prove or disprove anything about Federal Reserve interest rate policy under Bernanke.
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