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Memo to Fed: Keep Building on Positive Vibes

Memo to Fed: Keep Building on Positive Vibes

by Dennis Jacobe

As the Federal Open Market Committee begins two days of interest rate policy meetings today, investor optimism is more positive than it has been for a year. The UBS/Gallup Index of Investor Optimism* surged 35 points in June, reaching its highest level since May 2002. Both the Personal Dimension (up 19 points) and the Economic Dimension (up 16 points) of the Index increased significantly. Investor optimism also showed strong increases among both substantial investors (up 34 points) and average investors (up 36 points).

Given the recent increase in Gallup's consumer confidence measures and the sharp upward movement in investor optimism, FOMC policy-makers may be tempted to consider consumer/investor emotions as another positive factor complementing the highly stimulative economic environment that is beginning to unfold. In turn, they may conclude that a half-point cut in interest rates is no longer needed to assure a strong economic recovery by year's end. Unfortunately, this interpretation of the current consumer/investor psychology would be a big mistake.

Optimism Among Substantial Investors Continues to Increase

The Index of Investor Optimism increased 34 points among substantial investors (those with investments totaling $100,000 or more) in June, on top of a 12-point increase in May and a 50-point surge in April. This brings substantial investor optimism to 96, its highest point since reaching 101 in May 2002. Although optimism continues to increase among such investors, it still has a long way to go before reaching its March 2002 level of 155 -- its highest point in the past three years.

At the same time, the Index also increased 36 points among "average" investors, reaching 66 in June. This puts average investor optimism below its April 2003 level of 76, but otherwise at its highest point since May 2002. Right now, optimism among average investors is at 62, about the same level it was a year ago.

Why Is Investor Optimism Increasing?

Right now, investors have more reasons to be optimistic than they have had for a long time:

  • Much of the geopolitical uncertainty of the past year has been significantly reduced.
  • The equity markets have experienced a huge rally.
  • Interest rates remain low, money is readily available, and the Fed is expected to lower interest rates again this week.
  • Energy prices have fallen back to their pre-war levels.
  • Taxes have been reduced and talk of additional tax cuts continues.

Regarding the last reason, many observers may in fact be underestimating the positive impact of the recent tax cuts on investor psychology:

  • Fifty-two percent of investors say the tax cuts will help the investment climate, while only 11% say they will hurt.
  • Fifty percent of investors say the tax cuts will help the economy, while 21% say they will hurt.
  • Thirty-nine percent of investors say the tax cuts will help their personal financial situations, while 8% say they will hurt.
  • Twenty percent of investors say the tax cuts will help the federal budget deficit, while a much larger 49% say they will hurt.

Still, We Need a Big Rate Cut

Given these economic stimuli, why should the Fed cut rates by a full 50 basis points? The answer is very simple. Right now, the economic recovery is more emotional than real. Positive emotions dominate the economic outlook. Stocks are currently priced with the assumption of a strong economic recovery by year's end. Consumer and investor expectations are surging in anticipation of a better economy. Economists and politicians can barely restrain themselves as they jump on the bandwagon and talk about the positive economic outlook.

The problem is that the current economic fundamentals are not showing a commensurate amount of strength. In particular, business executives seem extremely hesitant to commit their companies to new capital expenditures. They realize that there was also a great deal of optimism about the economy in early 2002, and that many people built their budgets anticipating a strong second-half economic recovery that never took place.

FOMC policy-makers should take no chances this time around. We need the current positive consumer/investor psychology to spread to the business sector. We need businesses to stop focusing on increasing profits by squeezing costs and begin looking to grow their top line revenues. We need new hires to increase and thus overcome the current jobs recession psychology. A half-point cut in interest rates will significantly increase the chances that the business community will join the current emotion-based economic bandwagon.

*Results are based on telephone interviews with 1,008 investors, aged 18 and older, conducted June 1-11, 2003. For results based on the total sample of investors, one can say with 95% confidence that the margin of sampling error is ±3%.


Gallup https://news.gallup.com/poll/8683/Memo-Fed-Keep-Building-Positive-Vibes.aspx
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