Historically, the Fed's cycle of tightening and easing has had an interesting psychological effect on the markets and the economy. There is no question that beyond the fiscal impact of Fed rate adjustments, investors also derive a 'gut' response to these moves.

Characteristically, the cycles of Fed movements can be divided into three phases. These are defined as Accommodative, Equilibrium and Restrictive. Each has its own effect on investors' psychology.

To provide an analogy for these phases in layman's terms, imagine our national economy is a brand new sports car and Alan Greenspan is the driver. Greenspan's job is to keep the sports car cruising along at the speed limit of 55 MPH, which for this analogy is equivalent to between 1% and 3% GDP growth. If he succeeds at keeping the sports car at the speed limit, he has achieved economic equilibrium. He needn't accelerate or brake. However, the economy or (for the sake of this analogy) the sports car is prone to acceleration. As GDP growth reaches 5% this is akin to Alan's sports car cruising along at 85 MPH. As we are all aware, speeding along at this rate is very exhilarating, but it can also be quite dangerous. Sensing the danger, Greenspan enters into a restrictive cycle. He hits the brakes (raises rates) in an effort to decelerate the sports car (economy). As a result the sports car slows to 15 MPH, which is akin to 1% GDP growth. Driving along the freeway at a rate of 15 MPH is equally dangerous. It feels sluggish, non-productive and the result is that it takes you far longer to get to where you are headed.

During the restrictive phase of the cycle the Fed ratchets up interest rates in an effort to slow an economy from accelerating out of control. This was witnessed as recently as late 1999 and early 2000 during which time the Fed made six rate increases. It is interesting to note that the markets viewed the first few of these increases as Bullish indicators. This was because the first few increases appeared to be minor adjustments intended to control the aggressive growth of a fundamentally healthy economy. Forward surging motions increasing pricing power and rising earnings are, after all, the hallmarks of a Bull Market. As with anything in life, too much of a good thing becomes bad.

As the Fed continued to raise rates in response to the unprecedented economic growth of the tech boom in the late 1990's, the pendulum of investor sentiment began to swing back the other direction. Federal Funds Rate increases reached a crescendo of 6.5% in June of 2000, by which point investor sentiment over rate increases had markedly shifted. What was once yielded a potentially Bullish reaction now elicited an obviously Bearish one. Many investors began to feel that Greenspan hit the brakes too hard. By the time the cycle's last increase of 50 basis points was made in June 2000, the Restrictive phase of the cycle had run the gamut from Bullish indicator to Bearish.

At the inception of the subsequent Accommodative phase of the cycle, which began in December of 2000 as Greenspan tried to hit the metaphoric accelerator, investors were not quite ready to view the move as a Bear indicator. The prevailing sentiment indicated this round of easing was merely intended to rectify what many viewed as overly enthusiastic tightening throughout 2000. Most investors believed that the slowing economy would surely resume its acceleration.

As 2001 progressed it became more apparent that there were serious fundamental problems with the economy beyond overzealous tightening. The burst of the tech bubble, energy woes and other fundamental deficiencies conspired to confirm investors' worst fears. Each subsequent FOMC rate cut which should be viewed as a positive (100 basis points in January 2001, 50 basis points in March, 50 basis points in April, 25 basis points in both June and August, 100 basis points in October, 50 basis points in November and finally 25 basis points in December) was met with increasing pessimism and bearishness by investors.

Presently, the Fed Funds Rate is at its historical low point of 1 ¾ %. The expectation of the FOMC is that the current low interest environment, coupled with tremendous liquidity on the sidelines, the recently enacted tax-relief packages and the work-down of manufacturers' inventories should combine to break the grip of the current recessionary cycle which began nearly 18 months ago. True to form, the pendulum has embarked upon its return to the other extreme. At its upcoming scheduled meeting in January of 2002, investors speculate that the Fed may make one final 25 basis point reduction in rates. If the Fed decided not to make this final cut, many investors would view the absence of a reduction as a Bull indicator. The psychology being that the decision not to make another reduction signals the Fed's belief that the worst is behind us and the markets are poised to spring back.

It remains to be seen whether the FOMC will make yet another cut and if the psychology of the market will influence their decision at any level. In their most recent press release after the December 2001 meeting, the FOMC made the following statements, which reflect a modicum of optimism:

     "Economic activity remains soft, with underlying inflation likely to edge lower from relatively modest levels. To be sure, weakness in demand shows signs of abating, but those signs are preliminary and tentative. The Committee continues to believe that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future.

Although the necessary reallocation of resources to enhance security may restrain advances in productivity for a time, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate. "

Many analysts agree that another rate cut would do a large degree of damage to the fledgling recovery underway in 2002. Perhaps the psychological benefits of refraining from making the cut would outweigh the fiscal benefits of making it. Are you listening Mr. Greenspan?