If you're an investor who has grown tired of the same old game of Federal Reserve watching, you might consider playing it in reverse.
Forget scrutinizing the Fed and its chairman, Alan Greenspan, to try to guess what they will do next that might influence the course of the stock and bond markets. Instead, start watching the markets for clues to the Fed's next move.That's the approach some Wall Street analysts take these days, acting on the presumption that investors as a group are pretty good at sensing changes in economic conditions.
Individually, they may have plenty of trouble with the mysteries of the economy, just like the rest of us. But collectively, forced to back up their opinions with real money, they have demonstrated quite a bit of savvy.
If they think economic conditions are heating up, encouraging the Fed to consider tightening credit, market participants push interest rates higher in the bond and short-term money markets.
On the other hand, if they sense increasing weakness in business conditions, they nudge interest rates lower.
By anticipating what steps the Fed might take in its campaign to keep inflation in check, they may wind up doing some of the central bank's work for it.
This presumably makes Green-span's job, well, not easy, but at least a little easier than it might otherwise have been. Let the bond market take some of the heat for interest rate changes that are bound to be unpopular with somebody, whether borrower or lender, member of Congress or corporate manager.
"If the markets really are efficient, the implication is that we should be able to extract economic information from the markets them-selves," said Bob Prince, an analyst at Bridgewater Associates in Wilton, Conn.
"In other words, if the markets fully reflect all available information, then the markets should supposedly tell us whether the econ-omy is strengthening, inflation is rising, etc., relieving us of the need to read statistical releases."
The whole process isn't quite so neat and tidy, Prince acknowledged. In a complicated world, the various securities and commodities markets sometimes send out messages that prove inaccurate, or even contradict each other.
But in the current picture, he said, there are at least some consistencies. An index of 26 consumer stocks tracked by Bridgewater has lately been sagging relative to the market as a whole, suggesting a prospective softness in demand for consumer goods.
At the same time, Prince said the firm's index of prices in the commodity markets has been flat. The two indexes combined, he said have been declining for more than two years.
"Since demand and inflation represent two very important inputs to Fed policy," he observed, "the index serves as a useful leading indicator of changes in short-term interest rates.
"Since 1976, changes in the direction of this index have preceded every major trend in short-term interest rates."
Prince said it's still hard to predict the timing and direction of the next quarter-point change in the rates the Fed uses to put its policies into effect.
But as for longer-term trends in Fed policy, Bridgewater's analysis suggests that the next sustained move won't be to tighten credit, as many observers have been expecting since last summer.
Prince concluded: "The current trend implies a higher probability of future easing than future tightening."