Here's a weird idea The Fed could use: Wednesday May 6, 2:26 pm Eastern Time
Wall St. mulls Fed rate hike or margin adjustment
By Huw Jones
NEW YORK, May 6 (Reuters) - A Federal Reserve rate hike would not spell disaster for Wall Street's bull run if investors
viewed it as a pre-emptive strike rather than a scramble from behind the curve to curb inflation, analysts said.
Raising rates is not the Fed's only option.
The central bank could leave rates unchanged and focus instead on restraining asset inflation and raise margin requirements on
stock trades as the central bank is entitled to, analysts cautioned.
A higher margin could have a much bigger dampening impact in what many analysts see as a liquidity driven market.
At this stage, the street would interpret an interest rate rise as a pre-emptive strike, analysts say.
''In the long run, that would be good for the stock market,'' said Pierre Ellis, senior economist at Primark Decision Economics.
With U.S. inflation the lowest since the early 1960s, the Fed has no reason to introduce a series of rate hikes, analysts said.
The strong U.S. economy would help counter the impact one-off hike on the stock market.
Nevertheless, rate fears began stalking the corridors of Wall Street after news was leaked last week that the central bank had
moved from a neutral to a tightening bias on rates at its March meeting.
And, despite benign economic data since the leak, the jitters resurfaced again this week to stall blue chip momentum.
Denmark's shock rate hike also put the prospect of higher European and U.S. rates higher up on the financial agenda.
Stock investors now scrutinize economic data for any excuse the Fed could use to raise rates. The next key indicator is
Friday's April non-farm payrolls.
Fed Chairman Alan Greenspan will also speak at a banking conference in Chicago on Thursday.
The Fed's next policy meeting is on May 19. It last raised short-term rates by 0.25 percent to 5.50 percent in March 1997.
The key issue for stocks is how the 30-year Treasury bond yield perceives the move to raise rates, said Mark Vitner, vice
president and economist at First Union Capital Markets Group.
This would determine how much the yield moved up.
''If you see bond yields come up, then the stock market would have to trade at a lower price/earnings ratio (P/E or multiple),''
Vitner said.
Stock prices move inversely with interest rates, so higher the interest rates would mean a lower multiple.
''Right now, it looks like an increase would be a pre-emptive step,'' Vitner said. ''But stock market is going to have a tougher
time making the type of gains we have seen.''
The Standard & Poor's 500 index of the nation's biggest companies is trading on a 12-month forward P/E of about 22, up
from about 16 a year ago. Over the same period, the long bond yield fell about one percent.
Wednesday, the long bond was up 17/32 to yield 5.95 percent.
''If rates are increased, the P/E would not be knocked down that much because of the favorable business environment,'' Ellis
said.
Chuck Hill, director of research at First Call, which tracks corporate earnings, said the P/E would be knocked down initially
after a rate hike.
''The bigger threat to P/E is if the Fed does something to the margin requirements, because the biggest concern at this point is
asset inflation,'' Hill said.
''Interest rates are not the real threat to P/Es. Margin debt has gotten pretty high and there is no question there is some froth in
valuations in general,'' Hill said.
At present, buyers of stock need only put up half the amount of money needed to buy the shares, with the broker agrees to
give credit for the rest.
This 50 percent margin requirement, set by the Fed, has been unchanged since January 1974. Margin debt is at the highest
level relative to GDP since the 1920s.
Arthur Levitt, the Securities and Exchange Commission's chairman, agreed on Wednesday that margin debt is high.
''People are borrowing for some purposes that perhaps they would not have borrowed for in the past,'' Levitt told CNBC
Television. ''It's a time to be cautious.''
Raising margins would cool the ''equity market froth'' without damaging the economy, said William Barker, chief investment
strategist at Dain Rauscher.
''I think it's certainly a tool they have got to consider using,'' Barker said. ''But I don't think they will do it.'' |
