The Fed's Rate-Cutting Days Are Likely Over

There probably aren't many contexts in which something as uneventful as a pause would be cause for action. But when the Fed pauses, investors had better take notice. I certainly do. It usually means a sea change is at hand. The previous pause, which lasted from June 2006 until September 2007, marked the end of a round of interest-rate increases that began in June 2004. The subsequent cuts in the midst of the credit crisis have been unusually aggressive and even controversial. Two Fed governors voted against the most recent cut, as they did the one before that, in a rare display of open dissent. That makes it even more likely that the Fed's next move will be an increase, although the pause could last months.

So what are the implications for investors?

Generally speaking, everything that benefited from low short-term interest rates should go into reverse, and those that suffered from falling rates should begin to gain. Once the Fed starts raising rates, inflation fears should subside, the dollar should become stronger — indeed, that already appears to be happening — international investments should become relatively less attractive, and exports should weaken. In other words we should be prepared for the opposite of many of the major trends of recent months. Of course, no one knows for sure whether these scenarios will play out. But trends don't last forever, no matter how comforting they become, and one reason they don't is that the Fed's policy decisions change the landscape.

All of this should have a major impact on three sectors that have thrived recently: energy, raw materials, and food and agriculture. All are commodities that trade on global markets denominated in dollars, so the dollar's fall has played a large part in their seemingly inexorable rise. No doubt other, more fundamental factors, such as demand from emerging markets, have also played a significant role. But even the Fed projected a "leveling-out of energy and other commodity prices" along with "an easing of pressures on resource utilization." This may be wishful thinking given that gas prices have topped $4 a gallon in some places. But the Fed should know, since it has the power to influence those prices and seems aware that its recent easy-money policy has been a factor in soaring commodity prices.

While the realization that the Fed's rate cutting is over for now may mean an abrupt change in investment psychology, it's not necessarily bad for stock investors. I've been comparing the recent economic landscape to the 1990-1991 period, when the U.S. suffered through the savings and loan crisis and a recession that, while relatively mild, lasted from October 1990 until June 1991. History never repeats itself, but having lived through that malaise, the subprime-lending and credit crisis and resulting economic weakness (which may or may not turn out to be an actual recession) strike me as similar.