Rate Reduction Reactions

We've seen the pattern now two or three times: the stock market rises in anticipation of a reduction in rates by the Fed, then we get it, then the doldrums creep back in. Net result is basically no movement in the market as a whole (at a level that I would argue is about 20% too high).

This time it varied slightly: market expectations (at least from some) were for a 50-basis point (in plain English, that's half a percent) reduction. The market dropped on the announcement of a 25-bp reduction. One day of rebound (at least there was something; also some infusion of funds was announced the next day), then back to the doldrums.

I have a little different take on the ongoing story. I think the initial 50-bp reduction (September?) was the right move--then the Fed should have sat and watched. For one thing, these moves have a delayed reaction in the world--months, not minutes or seconds. Bernanke and the Fed got pressured to do more when there were continuing danger signals of a possible future recession after the first move. So?

The second point is that weak resolve from the Fed is going to end up leading to galloping inflation. We have all the engines for future inflation already in place: high and rising energy prices, increased costs as we substitute higher-cost sources of energy, trade wars about to set in, and a weak economy going into an election year. The scenario looks like this: jobs drop, rates drop, a brief recession accompanied by more rate reductions, a strong recovery and prices go out of control.

The Fed should announce that its reductions are over for several months and then gird its collective loin for the political attacks that will follow. Anybody remember stagflation? The pain required to get out of it (Volcker's recession of '80-'82)? I do.