The Fed & Interest Rates

The July producer price index figure shows wholesale prices surged 1.2% in July.   That's the biggest jump in 27 years.   Truly stunning, particularly when you consider many strategists believe we are entering a period of slower global economic growth.   Prices theoretically should be falling, not rising, as slower growth means (theoretically) slower demand.    Of course, economic theory has often proved an oxymoron.  

The featured markets guest on the program today was Sri Kumar, Chief Global Strategist at TCW Group.   He believes that even with continued tight lending standards and a weak housing market the Federal Reserve must - and will - raise interest rates sooner than later.   Though economic doves insist the Fed should stay on hold in its future meetings, Kumar shares my view that there are two primary reasons the Fed should increase the overnight lending rate: 1) we need to stem the increase in inflation and strengthen the dollar, and 2) a quarter-point (25 basis point) increase in rates will not further dent the weak credit market further but will instead give investors an important psychological boost.

When the Fed is cutting rates it is generally because the economy is weakening and the central bank is trying to stimulate growth by increasing lending and borrowing.    It's a 'sale' on money, if you will.   And many investors see Fed cuts as retailers see sales: a blunt instrument that customers know is meant to lure them in.    When something is not on sale its presumed there is sufficient demand to sell the product at full price, a bullish sign.  If the Fed raises rates Kumar believes it would make an important psychological statement about the health of the Fed's 'store,' the American economy.

The next Fed meetings this year are: September 16th (one day), Octboer 28-29 (two day) and December 16th (one day).    The first meeting in 2009 is January 27-28th (two day).  It's my and Sri's bet that the Fed will raise interest rates at one of those next four meetings.  Stay tuned.