Interest rate overkill?

Andrew Vaughan - Thu 03 Aug, 2006

...Statements from the Fed seem to have switched from giving coded guidance about the future direction of interest rates, to giving insight into the Fed's current economic hopes and fears. The upshot is something that investors hate more than anything else a lack of clarity about the future. Are we moving into an era of interest rate overkill?...

  
 
My first reaction this month when I ask myself "what to do with my money today?" is this. Go out and blow it on some exquisite fine art and a few cases of 2005 Bordeaux, a wine that is shaping up to be the best vintage that France has produced for years. At least I know what I am getting and my enjoyment is guaranteed.

I cannot say the same for shares, when it is utterly impossible to call the near-term direction of volatile financial markets. I wouldn't be alone. Indeed this sentiment and the state of the financial markets are not totally blameless for the record-breaking conditions currently being witnessed by the fine art and fine wine markets. As the old saying goes; there is always a bull market happening somewhere.

So what is it that is keeping financial market investors on the back foot? These words may be a bit harsh. Equity indices have recovered their poise since the dark days of last month, business sentiment remains strong and corporate activity continues apace. Indeed jittery markets successfully absorbed China's biggest flotation to date – Bank of China – and Rosneft looks on course to succeed with its initial public offering (IPO).

At around $10bn, that is a significant sum to be put forward for an investment of such questionable provenance. The rush of strategic investors – including such big names as Petronas, Temasek, China Oil and BP – very much confirms to us that Russian oil reserves are a must-have investment for the 21st century. Our recommendation this month of Baring Emerging Europe homes in on this theme.

No. What has changed since the opening months of 2006 is the conduct of the US Federal Reserve. Intriguingly, after 17 consecutive interest rate rises, the yield curve – which had become inverted while long-term interest rates were lower than short-term rates – is now back to a "normal" shape. Far from providing comfort, however, investors are simply confused.

Statements from the Fed seem to have switched from giving coded guidance about the future direction of interest rates, to giving insight into the Fed's current economic hopes and fears. The upshot is something that investors hate more than anything else – a lack of clarity about the future.

Are we moving into an era of interest rate overkill? Quite possibly, but if we are, the plus side is that it gives plenty of scope for rates to be cut should economic activity slow significantly. In short, the Fed wants to gain some ground uphill and upwind while the going is good.

Wall Street, meanwhile, must apply itself to learning a whole new language of "fed speak".


Regards,

Andrew Vaughan
for The Daily Reckoning