In the face of a looming inflation threat, this would mean that the Federal Reserve Board, despite its repeated public statements that it forecasts robust economic growth, now believes that the economy is beginning to falter seriously enough for the Fed to stop worrying about inflation and turn its attention to preventing interest rates from going into recession-inducing territory.
If the Federal Reserve truly sees serious challenges to its claims of strong growth in 2005, that would put the central bank in a very difficult position: it set out on the current series of measured, deliberate interest rate increases precisely because it saw signs that inflation was beginning to settle into the economy, despite its claims that no such signs were evident. However, as it increases interest rates, private consumers will cut back on credit-based purchases, and businesses will cut back on borrowing for maintenance and expansion. For a strong advocate of price stability to represent that the Fed now should turn away from the inflation fight indicates that other Fed bank presidents and Governors believe similarly that the economy is in serious need of a reprieve from the expectation of higher and higher interest rates.
Unfortunately, the Federal Reserve, through its Federal Open Market Committee, can do only so much to control the interest rate environment. If market conditions are pushing interest rates up that the Fed doesn't directly control, then the Federal Reserve can do only so much and only for so long to allow the rates it does controlprimarily the inter-bank lending rate called the "federal funds rate"to diverge from the market-controlled rates, such as those on corporate bonds, conventional mortgages, and commercial paper.
With the single most significant factor on interest rates being the large federal budget deficits, there is good reason to believe that the overall trend in interest rates, whatever the Federal Reserve might want to do to its rates to help the economy, is upward. This becomes a virtual certainty given that the Bush Administration is planning to embark on a plan to borrow "trillions and trillions" of dollars, in the words of United States Vice President Dick Cheney, to the end of privatizing the Social Security system.
In market news, bond prices rose on Guynn's statements, pushing yields on Treasurys down across the board, as investors saw a coming reprieve in the rising interest rate environment. Stocks, on the other hand, took a round beating today, with all of the major indices falling strongly because of the implied message from Guynn that the economy's health might not be as robust in 2005 as the Fed and the White House had for months been claiming it would be. Today's down draft on stock prices gives further evidence that the equities markets are now stuck in a "trading range" scenario, moving neither up nor down in any concerted, long-term fashion. The consequences of this trading range pattern are troubling for long-term investors in equity-based securities, since portfolios of stocks based on broad indices are earning no significantly positive rates of return as long as the stocks continue to bounce around without any discernible upward trend.
This situation is becoming a long-term, definable legacy of the current Administration, materially challenging any claim that the Bush Administration has created a business environment that fosters prosperity for investors, particularly average investors trying to grow a nest egg for large purchases or for retirement.