Inflation pressures have increased, reflecting the weak dollar and the direct effects of rising food and energy prices. The first two are readily understandable. Rising crude oil prices are much harder to explain, since inventories and capacity have increased, which would normally drive down oil prices. So, ad hoc explanations are provided, such as oil prices inversely mirror the dollar, so a firmer dollar should cause oil prices to soften. Even if this explanation is correct, the Fed's mission should be to help credit markets work better to ensure a recovery, which should also help the dollar. This argues for another rate cut, but also for more basic steps to help the markets work better.
The classical response to a weak currency is to raise interest rates to attract international capital inflows. But such policy action could counterproductively weaken credit flows, the primary cause of the weak economy. Mortgage rates have not fallen. Risk spreads have narrowed, but they remain quite wide. Much of the record amount of debt issued last week was to shore up the damaged balance sheets of financial institutions, not to finance capital investment that might stoke expansion. The economy is most likely to improve with time, but the absence of further policy steps might also permit confidence to weaken in the face of continued credit problems. Since an improving economy is not yet assured, it is premature to think the Fed's job done.
Additional policy actions need not take only the form of downward rate adjustments. The raft of new facilities to promote lending and the functioning of credit markets is also very important. The mortgage market merits special attention. A turn in construction, which is not yet visible, would be a definitive development that would improve confidence and bring liquidity back faster to mortgage securities. The huge decline in new construction has helped, but only modestly so far, since sales have fallen off nearly as rapidly as starts, so inventories have declined only very slowly. Any policy change that boosted sales would be enormously powerful and beneficial in restoring confidence and improving the growth outlook.
Enough progress has been made to change investor perceptions. While economic activity is likely to remain sluggish a bit longer, much of the groundwork has been put into place to improve the outlook. Still, risks remain. So, the Fed will likely continue to shift its focus from rate reduction to improvements in the plumbing and infrastructure of the financial system. It isn't as sexy as a rate cut, but the long-term implications are jut as beneficial, yet longer lasting.
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About Advisors Capital Management, LLC
Advisors Capital Management, LLC (ACM) is a provider of managed portfolios and financial services for industry professionals and their clients. As investment strategist, Dr. Lieberman oversees the company's "Portfolio Partners" investment program. Additionally, he provides guidance to the ACM Wealth Coordinators who integrate the work of financial advisors, financial planning, tax, estate and portfolio management professionals to build, protect, and maintain clients' wealth. Although the information included in this report has been obtained from sources Advisors Capital Management, LLC believes to be reliable; we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
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