Cue the selloff, as investors suddenly felt less certain that the Fed would come to their rescue

Inflation comments sour sentiment

RTGAM




Take one tentative stock market rally, add a Fed official's comments about inflation and watch the rally fizzle. This was the recipe for Wednesday, when North American stocks came out of the gate with a jump but then stumbled in the afternoon, leaving major indexes down for the day and dashing hopes for a turnaround following the big selloff on Tuesday.


The inflation comments came from Charles Plosser, chief executive officer of the Federal Reserve Bank of Philadelphia, during a speech at the Birmingham Rotary Club. A lot of the speech was mere throat-clearing, but his thoughts on how the U.S. Federal Reserve must approach rate cuts in the face of troublesome inflation were particularly arresting.


Here is the part that took investors by their lapels and shook them: "There are those who have expressed the view that in times of economic weakness, the Fed must not worry about inflation and should focus its entire effort on restoring economic growth by dramatically driving interest rates down as far and as rapidly as possible. To borrow a line attributed to that famous, or perhaps infamous, Union Admiral David Farragut at the Battle of Mobile Bay, it is sort of a 'damn the torpedoes, full speed ahead' approach to policy. But the Fed has a dual mandate for a reason. Price stability is a necessary component for achieving sustained economic growth. Ignoring price stability during times of economic weakness risks undermining our ability to achieve economic growth over the long run. It fuels higher inflation down the road and risks inappropriate risk taking and recurring boom/bust cycles. This would be counterproductive."


Before the speech: According to fed funds futures - via David Rosenberg, North American economist at Merrill Lynch - investors believed that the Fed would cut rates by half a percentage point on March 18 and would bring rates down to just 2 per cent by August.

After the speech: Cue the selloff, as investors suddenly felt less certain that the Fed would come to their rescue.

The Dow Jones industrial average, which had rallied as much as 125 points, ended the day at 12,200.1, down 65.03 points or 0.5 per cent. The S&P 500 closed at 1326.45, down 0.8 per cent, weighed down by Apple Inc., CME Group Inc., Chevron Corp. and Microsoft Corp. In Canada, the S&P/TSX composite index, up 135 points mid-day, ended at 12,867.2, down 64.75 points or 0.5 per cent, in a decline was fed in part by lower oil prices. The biggest losers included Research In Motion Ltd., EnCana Corp., Canadian Natural Resources Ltd. and Petro-Canada.

Copyright 2001 The Globe and Mail

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