Fed heads like me will be parsing the FOMC statement on Wednesday for clues regarding the future of monetary policy, which naturally will affect the valuations of all asset classes including currencies, stocks, and commodities. The first thing that any Fed watcher does is to look for changes from the previous statement, so let's break it down to the three main areas of interest. |
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Interest Rates ![]() |
Inflation ![]() Be aware that when the Fed talks about inflation what they really are most concerned about is the potential for a wage-price spiral as seen during the 1970's. The reality is that there's very little chance of seeing that occur anytime over the next several years. For one thing, there are much fewer unionized workers. Second, and even more important, there obviously is an oversupply of workers relative to the amount of jobs available which means there's little pricing power among employees. Third, companies don't need to hire more workers because contrary to what usually happens when companies eliminate jobs, productivity (worker output per hour) is rising (6.4% in Q2 on an annualized basis according to Tuesday's report). Aside from that, the report also indicated that labor costs fell the most in eight years over the period. |
Economic Growth

Putting these three together really indicates that a sweet spot exists for stocks, because the economy is set to improve while policy looks to remain expansionary as inflation remains low. The latter point is especially important because it means that in real terms (taking inflation into account) any percentage gains will be that much higher, i.e. that the purchasing power of the dollars you receive when you cash in your investments will not have eroded to an appreciable degree.
Those factors certainly have been great for stock investors; the S&P has gained nearly 12% since the FOMC met on June 24. The problem is that for forex traders, the concurrent movement in the dollar (short) against the euro, pound and A$ hasn't been quite as pronounced during that period although those currencies did make significant moves against the yen (they have made significant gains on the USD overall since March). Also of note is that USD/JPY, which basically mirrored S&P movements for several years, hasn't done anything of note since the March rally although it the yen does gain rather dependably on days when stocks retreat.
The Fed may also make a decision regarding whether to extend its $300B program to purchase Treasuries. If they choose not to continuing purchasing U.S. debt it could cause interest rates to rise, which will tend to put downward pressure on the dollar. Also, Congress wants the Fed to extend its program to purchase commercial mortgage backed securities for another year, so look for the FOMC to comment on that.
Commercial real estate is likely to present the biggest obstacle to economic growth over the medium term. There's a crisis looming there because of the inability of property owners to refinance debt which is coming due. Rents and property values have fallen dramatically, which means that there will be less income available to service the debt and that banks will require any loans they do make to have lower loan to value ratios. Property values are forecast to remain depressed which means that many owners are underwater on their mortgages, another recipe for rising foreclosure rates.
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