Fed Rally Fading

Last week's Fed-inspired stock market bounce appears to be slowing down. It is possible that a brief pause will refresh the forces of bullishness and allow the benchmarks to break out to new highs. It is also possible that lower short-term interest rates will turn out not to be the economic panacea some expected. The Fed has administered medication with significant side effects that may or may not be tolerable. Long-term interest rates, for example, surged as it became clear that Ben Bernanke is not quite the inflation hawk he used to be. For example, stressed homeowners who thought they could refinance their adjustable-rate mortgage to a 30-year fixed-rate loan are finding that option is no longer as attractive, if it is available at all.

In the economic big picture, lower interest rates mean a bigger money supply. More dollars in circulation means that each dollar is worth a little less than it used to be, as compared to other currencies or to tangible goods. This phenomenon is called "inflation" and the markets seem to be anticipating more of it in the near future. Gold and crude oil shot up in the last week for that very reason. Gold is perhaps a better proxy for the monetary aspects of inflation, but energy may have more upside. Consumers around the globe who have little use for gold coins and jewelry have little choice about buying petroleum-based products. Rising prices the last few years have shown little impact on overall demand. With Treasury futures trading indicating that more rate cuts are likely, the downtrend in the dollar and concomitant uptrend in commodities seems likely to be with us for some time.