Market Directions Sunday, October 21, 2007
The equity sky suddenly grows stormy
The G7 meets and ...
ECB rate policy, made in Washington?
There is still a week and a half before the next FOMC decision on October 31st. Fed Chairman Ben Bernanke has said repeatedly that the decision will be determined by the state of the economy as reflected in the statistics. But the Fed now has a new worry, the equity market. If Thursday's poor jobless claims number had tilted the speculative see-saw toward a 0.25% cut then the Friday collapse in stocks will keep the lever pinned to the ground. Can the Fed not cut rates again?
Even though several important statistics will be released before the Fed decision, the futures market had, by late afternoon on Friday, fully priced in a 4.5% Fed Funds rate. The day before the same futures pricing had predicted only a 48% chance for a rate cut. None of the pending statistics, Durable Goods Orders, Consumer Sentiment, the Chicago Purchases Index, 3rd quarter GDP and three housing figures will allay the Fed's economic fears. When the Fed meets it will also be able to consider the pre release ISM, PCE inflation and Non Farm Payroll numbers for October. Even the best results for these numbers are now unlikely to prevent additional Fed rate cuts and none will provide support for the Usd.
No one statistic of the past several weeks has been strongly Dollar negative. Most have shown continuing moderate growth in GDP and consumer spending but the Dollar has continued to fall. The problem for traders is that the market sentiment is overwhelmingly against the USD. That sentiment cannot be altered by rationed good news or a moderately expanding economy. The governing market assumption, one might call it the 0.5% thesis, is that the strains on the US economy will keep the Fed on the defensive and the economy from trend growth for the next two quarters. Bad sentiment cannot be driven out by mediocre news; the Dollar cannot recover while the Fed is the only central bank reducing rates.
The logic for this FOMC meeting is the same as it was for the September 18th assembly last month. The danger posed to continued moderate economic growth outweighs the potential exacerbation of inflation. If the Fed had this one good reason to cut rates last month does it now have any good reasons not to cut? What could the Fed view as more important than economic growth? Moral hazard in the financial markets? The six month horizon for inflation? The falling Dollar? None of these possibilities can overcome the economic damage from a recession. In fact all of these concerns, while real, will be made measurably worse if the economy slips into recession. Inflation is tame. Growth worries can only have been made worse by Friday's equity slide and the credit market problems have not vanished. The question can be asked again. What good reason does the Fed have for not cutting rates? It is difficult to formulate an answer. In addition, it would be rare in modern Fed history for the bank to cut rates only once in a cycle. If the Fed cuts on the 31st logic predicts further cuts as well. If the Fed rate reduction horizon has just lengthened then the decline of the Dollar has also.
In the something for everyone department the G7 communiqué is one of the best. The foreign exchange paragraph of this communiqué is worth quoting in its entirety. “We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange markets closely, and cooperate as appropriate. We welcome China's decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we stress its need to allow an accelerated appreciation of its effective exchange rate”. Issued by the assembled finance ministers after Friday’s meeting in Washington its virtue is to please all without offending any. Anyone that is, as long as one is not from Beijing. “Excessive volatility” satisfies those Europeans who dislike a high Euro and Euro/Yen; China’s mention satisfies all manner of trade warriors; “monitor” and “cooperate” keeps the internationalists happy. Every finance minister and politician can find in the text the appropriate phrase for reference during their news conferences back home, whatever the inclinations of the national audience.
BECAUSE YOU CAN READ THIS, THANK A TEACHER. BECAUSE IT'S IN ENGLISH, THANK A SOLDIER.
