Issue 16 - June 1, 2004


Who’s Afraid of The Big Bad Fed?

The broad financial markets have at long last taken their first step towards accepting the inevitable: interest rates are going to rise. However, rather than embrace the strong economic environment which demands a return to normalized levels of interest, our markets are being swept under a wave of worry.

As we have mentioned in prior letters, it is difficult to truly appreciate how accommodative the Fed has been since 9/11/01. For the past 20 years, the Federal Funds rate has closely approximated nominal GDP growth. There have been periods where the benchmark has been slightly above or below as the Fed has used their most powerful tool to either stimulate or tame the economy, but we have never witnessed the severity of disconnect that these past few years has provided.
The Fed is a full 300 basis points below the current GDP of 4.4%.

However, as the popular press spends endless energy debating the timing and implications of the first 25 basis point increase, they have missed the preemptive rise in longer term rates. The market, however knows its history and has already put back into term rates perhaps as much as 50% of what would be required assuming a 5.50% 10 year US Treasury yield. Recently, we have been able to recommend 10 year, AAA Municipal bonds at yields last seen in June of 2001. Fed Funds just happened to be at 4% at that time.

Given the distance the Fed needs to cover, we would think it likely that they will begin adding back in 25 basis points at each of their meetings through the end of the year. That would get the benchmark rate back to 2.25% to begin 2005. This also gets them with “spitting distance” of their target of 3% - 4%. While we see many surveys which suggest that the Fed will move much more slowly or perhaps take a breather for the election, we would politely point out that there are a number
of reasons why the Fed needs to get a move on. First and foremost, the economy is not going to slow down while the Fed is 100 to 200 basis points below baseline.
They need to catch up before they could effectively slow down an accelerating economy and inflation. The Fed has always known they would run the risk of overheating the economy while they patiently waited for irrefutable evidence of a
self sustaining economy. They now have the proof they need and must get the US economic ship back on an even keel. While a rising rate environment will undoubtedly create a bumpy investing environment: it will provide opportunities for investors to reload depleted municipal portfolios, and equity portfolios will be able to rely on the continuing strong productivity and economic fundamentals to fuel their forward progress.


In this Edition

  • Big Bad Fed

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

15 -05.04.04
Rising Rates/ Google IPO

14 -04.01.04
First Quarter 2004

13 - 03.02.04
2004: Encore Performance

12 - 02.03.04
Market Outlook/Cell phones

11 - 12.16.03
Auctions - eBay, US Treasury, IPOs

10- 12.02.03
Recent Economic Data
Market Implications

More Past Issues
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Market Highlights

  5/28/04 3/31/04 12/31/03 12/31/02
DJIA US 10188.5 10357.7 10453.9 8341.63
S&P 500 US 1120.68 1126.21 1111.92 879.82
Nasdaq US 1986.74 1994.22 2003.39 1335.51
EAFE Int'l Equity 1300.45 1337.07 1288.77 952.65
5 Yr Treasury 3.825 2.89 3.231 2.74
5 Yr AAA Muni 3.14 2.38 2.45 2.59
10 Yr Treasury 4.686 3.874 4.225 3.82
10 Yr AAA Muni 4.06 3.49 3.6 3.72
30 Yr Treasury 5.225 4.69 5.01 4.77
30 Yr AAA Muni 4.94 4.51 4.54 4.69
EUR Currency 1.225 1.2227 1.2612 1.0488
JPY Currency 110.83


106.92 118.69
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