The Truth Comes Out

And the truth is. The U.S. Federal Reserve plays very close attention to the stock market. Why? Because history has proven that the direction of the stock market most likely leads the economy by several months.

In the spring of 2000, NASDAQ stocks started a one-year decline which saw the NASDAQ Composite drop by 60% within the next 12 months. Similarly, the S&P500 and the Dow Jones Industrial Average fell about 25% in the same time period. The result? By the spring of 2001, the U.S. was in a full blown recession.

Minutes of Federal Reserve meetings are released five years after they take place. This week, Washington released the transcript of the Fed’s 2000 meetings. A review of those meetings reveals the Fed Governors candid discussion on the direction of the U.S. stock markets.

Meeting minutes also show Alan Greenspan was very anxious to raise interest rates when the U.S. economy was doing well. In 1998, 1999, and 2000, the U.S. grew at an average rate of 4% per year, prompting the Fed to aggressively raise rates in May, 2000.

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What does this mean to you and I?

If the U.S. economy continues to expand, interest rates will continue to rise. Most analysts predict the U.S. economy grew 4% in the first quarter of 2006–hence interest rates will remain or move higher.

Even though it should have not been a surprise, from the release of the 2000 Fed meeting minutes we now know the Fed is very interested in the direction of the stock market. Hence, the famous term “The Greenspan Put,” which means analysts believe if the stock market fell too much, Greenspan would lower interest rates to stimulate the stock market (akin to a major put option against stocks).

But, with the stock market (Dow Jones Industrial Average) toying with a new six-year high, the prospects for the economy look bright. So in terms of the Fed’s concern for stock prices, there will be no hesitation on the part of the Fed to raise interest rates in the months ahead unless stocks start to nosedive.