Last month when we suggested that the financial markets would be choppy for most of March and April, we probably should have substituted the word "choppy" with turbulent. Remember, the Dow was on the verge of trading above 11,000 for the first time in 4 years and now we are below 10,500. As expected, the Fed, on March 23rd, raised the rate on federal funds by 25 basis points to 2.75%, but what wasn't expected was their comments on inflation which sent bond yields soaring. And, the price of oil continues to climb and is now trading closer to $60 per barrel than $50. So, what happens next? What is going through our minds is that the media never seems to pick up on anything positive about the markets or the U.S. economy. In fact, if you listen to the pundits it would be easy to fall into the trap that Europe, with its high unemployment and slow economic growth, is the secret to success. Well, this makes no sense and over time will be dispelled as myth. With that said, the one thing we know for certain is that when things appear to be so bad, then they can only get better.

The Fed did raise rates by 25 basis points for the 7th straight time going back to June 2004 when funds were at 1.00%. The wording that followed left us a little surprised: they hinted that "pressures on inflation have picked up in recent months and pricing power is more evident." This is the first indication that the Fed is shifting toward fighting inflation in earnest and signals more aggressive rate hikes going forward. But wait a minute! The Fed got it wrong in 1999 and the bond market believed their view. But this time around the bond market is not as convinced about inflation concerns as the Fed. If the bond market felt as the Fed does about the economy, long rates would be a lot higher than 4.75%. This tells us that there are many investors around the globe that share our belief that locking up long bonds at current rates is not a bad idea.

Only time will tell whether the pundits are right or wrong but our senses argue that buying bonds in the 2-4 year range is prudent for the bank portfolio manager.

Faster growth and inflation may increase expectations that the Fed will keep raising rates but think of the Fed and the economy in this manner. Picture a person "the Fed" flying a kite "the economy" as the wind "growth" starts to pick up. Now, if the Fed let go of the string or let out 20 yards of string, what would happen? The kite would spin out of control and hit the ground. Or, what we think is going on is that the wind "growth" is blowing and the Fed is letting string out in a controlled fashion while keeping tension in the line. So, a 2.75% funds rate signals that the Fed is letting out just enough string to keep us moving forward at a sustained pace. As always, there are many forces in play but if the dollar can do better and oil prices can pull back, then the Fed might be closer to taking a time-out than the market thinks.

Declining stock prices are being driven by inflationary growth in the service sector and record high oil prices. A weaker than expected job creation report for March, which would ordinarily dispel inflation fears, did nothing to bolster confidence in the equity market. The rationale is that businesses will have to pay more for crude oil and other raw materials, diverting cash that could otherwise be used for hiring more workers. Only 110,000 new jobs were created in March, which was half of what was expected, while February was revised lower by 19,000 jobs. The nation's unemployment rate actually declined from 5.4% to 5.2%, but no one seems to care. What we do know is that corporate America is sitting on record amounts of cash and they continue to increase dividends and stock buyback programs. Earnings continue to be in line with expectations and the outlook for future sales is good.

Look for more of the same short term but remember that markets take off when everyone is bearish.