A Fed Rate Cut Doesn't Matter

Bill Byrnes — Mon, 17 Sep 2007 13:11:00 -0500

So, what’s the Fed going to do tomorrow? I continue to believe it’s possible there won’t be a cut in the Fed Funds rate. I also believe the stock market will respond negatively, whether or not the Fed cuts rates.

The Fed might not cut rates for four reasons: The self-correcting mechanisms containing the subprime mortgage/debt securitizations problems are working smoothly. Pimco, and few organizations know more about debt than Pimco, announced the launch of a distressed debt fund last week. Pimco is the second major financial firm to make such an announcement. The debt market is correcting itself. A second reason why the Fed won’t cut rates is fear of inflation as evidenced by rising energy prices. Oil was back at $80 per barrel last week. The economy is still growing. Granted, the last jobs report was weak but one report doesn’t make for a sea change. Solid retail sales offset the jobs numbers (at least for now). Lastly, US exports are strong because of strong global demand and that buoys our growth.

Whether or not the Fed cuts rates, I expect the market to react in the same way – it will go down. This will be a short term reaction but it’s based upon the assumption that if the Fed cuts rates, it will be fulfilling the market’s expectation and the old adage of buy on rumor, sell on fact will hold true. If the Fed doesn’t cut rates, (some) investors will be disappointed and the stock market will decline. It will only be a brief sell off, then the market will resume trying to figure out the fundamentals, so let’s take a look at them.

The big question is whether there’s a recession in the offing. The answer to that will become clear over the next 30 - 45 days as we get additional information on employment, retail sales and, in October, third quarter earnings reports. Stay tuned. Right now, it is anyone’s guess as to whether we’ve in a mid-cycle slow down or on the cusp of a recession. If a recession is coming, expect the stock market to decline by 15% from present levels.

The mortgage debacle has been picked over but one aspect of it which hasn’t received enough attention is that most adjustable mortgages are re-set based upon LIBOR (London Interbank Offered Rate), not a US interest rate index (and certainly not the Fed Funds rate). LIBOR is a global index, impacted only in part by what’s going on in the US. Because of stronger economies, central banks around the world are tightening rates. Thus, there’s upward pressure on LIBOR. The result may be an unpleasant surprise for US home owners who discover that their mortgages rate has been re-set higher, rather than lower, even if US interest rates decline. This could be the ticking time bomb that pushes the US economy into a recession.

For now, let’s use any market correction as a buying opportunity, all the while having identified our sale candidates if future economic news is not good.

The MUTUALdecision Blog: A Fed Rate Cut Doesn't Matter

A Fed Rate Cut Doesn't Matter