Donald L. Sazdanoff's Barron article is a concise warning of potential issues in Fed policy. The theory:
- Fed is sending out a message that interest rate will be stable for a "considerable period," which issues a warrant for investors to drive stock prices up without considering the fact that the rate will rise eventually
- To avoid economy overheating without raising interest rate, Fed has to reduce the growth in money supply, which it did in the past few weeks.
- This is similar to Fed's wrong moves during 2000 bubble: it wanted to keep interest rate high and ramped up money supply but the strategy backfired.
- If this reduction is part of Fed's unannounced policy change, then it may pose potential problem for the market. Once interest rate rises, Fed has one less weapon to use.
Another Barron article also mentioned that "in a Reuters poll of the 22 bond firms that deal directly with the Fed, 11 said they expected the fed-funds target to close out 2004 at the current 48-year low of 1%, if not lower." This means market expectation is really high for a stable interest rate environment for another 12 months. Any Fed's action to hike interest rate may be a huge hit to the stock market.
My personal feeling is Fed is again contributing to a booming (or bubbling) stock market (for Mr Bush's reelection?), and interest rate will rise anyway sooner or later, and so as inflation. I'll try to me mentally prepared for this.