- The Washington Times - Tuesday, July 4, 2006

Any day the Dow Jones Industrial Average jumps more than 200 points is a good day. On Thursday, the Dow soared 217 points, closing at nearly 11,200. At a tad under 2 percent, the Dow’s advance was its best day in more than three years. Particularly noteworthy was the fact that the Dow jumped more than 135 points after 2:15 p.m., when a Federal Reserve press release announced that the Fed had raised its short-term target interest rate by a quarter-percentage point to 5.25 percent.

What encouraged investors was their interpretation of the Fed’s press release, and that it differed from the May release. Specifically, on May 10, after reporting a quarter-point increase in its target interest rate, the Fed said “some further policy firming may yet be needed to address inflation risks” and that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information.” On Thursday afternoon, the Fed said “some inflation risks remain.” The statement went on to say: “The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” From the latter statement, Wall Street inferred a potential pause in the tightening cycle. Investors backed up that inference by sending the Dow (and the Nasdaq, which increased by 3 percent) soaring.

Interestingly, Wall Street chose to ignore another major difference in the two press releases. On May 10, the Fed confidently reported that “the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation.” (The Fed obsesses over core inflation, which excludes energy and food.) In contrast, the Fed’s June 29 press release worrisomely acknowledged that “eadings on core inflation have been elevated in recent months.”

Time will tell whether Wall Street appropriately reacted to a nuanced change in Fedspeak, while choosing to ignore an ostensibly far more significant change.

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