Fed Fear Panics the Herd

Imagine an African wildlife scene. A herd of peaceful zebras surrounds a watering hole. Suddenly they all perk up and look toward the adjacent trees. Something lurks there, something threatening — or so they think. As soon as one member of the herd decides to run, a stampede will follow. It does not especially matter if the threat is real or not. Better safe than sorry, especially if you are a zebra who lives in lion country.

This is a good analogy for how Wall Street works. Investors are the zebras, and Ben Bernanke is the lion which is even now poised in the jungle, ready to strike. Tomorrow afternoon the Federal Open Market Committee will announce its latest interest rate policy decision. Having decided that recession won’t be so bad after all, traders now want the Fed to turn its attention to stamping out inflation. This is amusing since not too long ago many of these very same people were telling us inflation is not a problem. Nonetheless, they now think the Fed will announce an end, or at least a pause, in its rate-cutting campaign.

Since markets discount the future, the trends that were sparked by lower interest rates — mainly a weak dollar and rising commodity prices — sharply reversed themselves in the last week. Energy, metals, crops and livestock all tumbled today. The U.S. dollar hit a three-week high against the Euro. Technology stocks rallied. Materials stocks fell.

Given this, I won’t be surprised if tomorrow’s announcement from the Fed brings a giant yawn from the herd… unless it is a surprise. What the Fed actually does tomorrow is probably less important than what they say. If the statement doesn’t include some new language promising increased vigilance for inflation, there could be a huge snap-back rally in commodities and a plunge in the dollar. I’m not predicting such a thing, but I think it’s possible. We’ll know tomorrow afternoon.