Donald Lambro

WASHINGTON -- Expectations that the Federal Reserve's interest-rate hikes are nearing an end has re-energized Wall Street's bull market -- perhaps even Americans' optimism about the economy.

Last week's stock rally, fueled not only by news out of the Fed but also by new corporate earnings and profit reports, was further evidence that the economy is operating on all cylinders, producing jobs in increasing numbers and finally earning the respect it deserves from financial markets.

There was also a palpable sigh of relief at the White House and among Republicans in Congress that this year's continued rise in stocks may be just what is needed to repel the Democrats' furious election-year offensive.

It is going to be much harder for Democratic candidates to argue that the economy and the country are going to hell in a hand basket when businesses are reporting higher profits, jobs are in increasing supply and worker retirement plans are getting richer.

Higher business revenues and fatter profits also mean increasing tax revenues at federal, state and local levels. Indeed, most state governments are reporting budget surpluses and it will not be long before we will likely see another spurt of deficit-cutting revenue in federal coffers as well.

The economic news heading into last week, with the glaring exception of oil and gas prices, was pretty good to begin with.

The March job numbers were great, shrinking unemployment to 4.7 percent -- lower than the average rate in the 1960s, 1970s, 1980s and 1990s. We've created over 5.1 million new jobs since August 2003, more than Europe and Japan combined.

Consumer confidence was climbing, with the Conference Board Index rising to 107.2 in March, its highest level in nearly four years.

Real disposable incomes were up 2.2 percent in the last 12 months. In fact, real per capita after-tax income has risen by 8.3 percent since 2001.

Inflation, that wearily worrisome boogeyman that frightens the Fed so much, has not been as scary as they feared. Core inflation, when volatile food and oil prices are excluded, rose by a tame 2.1 percent in the last 12 months.

But last week's news out of the Fed, which cheered the stock markets, appeared to be a sign that they no longer feared inflation, or at least the core rate. Instead, they feared that their credit tightening could go too far in their efforts to cool the economy and sandbag it in the process, a concern raised in this column in February.

"Most members thought the end of the tightening process was likely to be near," said the minutes of the Fed's last closed-door meeting on March 27-28. That was the operative sentence that sent Wall Street into a frenzy of stock buying.

But the minutes also explained the fears that were expressed around the Fed governors' table as they raised the federal funds rate another quarter of a point to 4.75 percent, the highest in five years:

"Some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy," the board's minutes said.

Well, I'll be darned, that was exactly the fear expressed in my Feb. 20 column which said:

"This is why economy watchers are worried that (Fed Chairman Ben) Bernanke will misread his economic tea leaves and raise interest rates longer than necessary. The long march upward in quarter-point hikes may seem harmless at the Fed, at least in the short-term, but it's their hidden long-term impact that we should be concerned about."

In that column, I quoted economic strategist Dave Smick, who heads an international consulting firm here, warning that, "If you wait until you see signs of weakness by raising rates, you will generally overshoot in the context of monetary policy because once the weakness appears you still have six months of the effects from tightening still to come out."

This fear of overshooting was spelled out in the Fed meeting's minutes, and it will be the chief reason when they decide to stop raising rates.

But what about oil prices? Won't they worsen inflation? Perhaps, if the price keeps rising. But that did not happen last year when oil went to $50 a barrel, then to $60, then to $65. The economy seemed to absorb the price hikes without any serious impact on its growth, jobs or the core rate of inflation. I think that will be the case this year as well. There is nothing wrong with the price of oil and gas that new, aggressive exploration, drilling in the outer continental shelf and in Arctic National Wildlife Refuge, and a lot more gasoline refineries cannot cure. For now, though, with gas prices hitting $3 a gallon for regular, I suspect we will see a drop off in gasoline sales as motorists cut back a bit on their driving, and a rise in inventories as refineries push to meet demands. The market place always responds to higher prices.


Donald Lambro

Donald Lambro is chief political correspondent for The Washington Times.