24 April 2008

Weak Dollar + Rising Interest Rates = End of Bear Rally?

Avner Mandelman in The Globe and Mail wrote an interesting column back on April 12 (a Saturday) on former Fed chair Paul Volcker's public criticism of Helicopter Ben's current Fed.

[L]ast week Mr. Volcker spoke his mind bluntly. He said, in effect, that the current Fed is not doing its job.

This would have been unusual enough. But Mr. Volcker went further. Not only is the Fed not doing its job, he said, but it is doing the wrong job: It is defending the economy and the market, instead of defending the dollar. And just to stick the knife in, Mr. Volcker added that this bad job now will make the real job - defending the greenback - much harder later. It'll cause even greater economic suffering.

The impetus of the column is not merely that a politician who should know better spoke out of turn, but that the current bear rally is indeed only that, a temporary upward move in a market facing the overdue need to strengthen the dollar.

Will rates indeed rise? I have no doubt they must. Not now, perhaps, but at the end of this year or the beginning of 2009, with a new president in the White House. The stock market, which usually looks six to nine months ahead, already understands this and may soon react. In fact, when Mr. Volcker's words sink in, the markets are likely to sink as this bear market rally ends.

For surely you understand we are still in a bear market - and only in the beginning of it? Yes, we are experiencing a rally, and like most bear rallies, it is sharp and spiky. But when bear rallies end, they leave a lot of spiked bulls behind - and this rally should be no different. When it is over - in the next few weeks, methinks - the waterfall could continue, as the market begins to digest the inevitability of higher inflation and higher interest rates ahead.

Against all protocol, Mr. Volcker just went out on a limb and warned you of this. I urge you to heed his words.

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