Today, the Federal Open Market Committee (FOMC) agreed to cut the Fed Funds rate 50 basis points to 3.0 percent and the discount rate by 25 basis points to 3.5 percent.
This level of cut was widely expected and right in line with our forecast. On Monday I said, "I believe that our FOMC will become emboldened on Jan. 30th and may lower rates by 50 basis points, possibly even more if they get really brave."
Well, the Fed moved in the right direction, but it did not get really brave. We will all suffer as a result.
American stock markets had expected this cut and rallied mildly, following a series of mini anticipatory rallies over recent days.
The recent market climb, however, points to the clear continuation of a disconnect between the stock markets and the economy.
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Stock markets benefit from lower interest rates, which lower the cost of capital to corporations. Lower rates also raise the present value to shareholders of the projected earnings streams of those corporations.
However, I believe the Fed lowered rates in an effort to forestall a looming recession — not to help stock markets.
In other words, the Fed clearly feels, as I have long forecast, that our economy is worsening. With GDP growth falling to a mere 0.6 percent for Q4 of 2007, there is now a real risk of recession — a recession which would result in a real fall in corporate earnings, even overseas.
There is also growing evidence that the so-called "economic decoupling" is unproven, in other words, that a recession in America still is likely to cause a significant slowing of the total world economy.
With this in mind stock markets should be falling, not rising! To that extent, this stock market rally represents a "suckers' rally" and is likely to prove dangerous.
I believe the Fed has moved in the right direction but has again proved too timid and too late to avoid the looming recession.
The sad thing is that we will pay the price of a deeper recession and, at the same time, the cuts will fan inflation, perhaps even stagflation, more so than would have been the case had the Fed acted sooner and with conviction.
The fact is, many other competing central banks still feel the main political battle is to combat inflation.
Until they finally wake up to the fact that avoiding recession is the real political battle and start to follow our Fed, our U.S. dollar can be expected to weaken.
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As our Fed is leading the world to lower (that is, recovery mode) interest rates, America is likely to be the first to recover from recession.
As I said earlier this week, I believe that international currency investors will soon wake up to the fact that an American recession will cause at least a significant slowdown in the world economy.
They will then see that the best total return (as opposed to current interest return) is likely to be offered by the currencies that will be first out of recession — including the U.S. dollar!
So, in the short-term, today's Fed cuts will help lessen but not prevent a coming recession. At the same time, the cuts will fan inflation and may cause some further weakness in our dollar.
To be fair, it is probably fear of these two implied costs that are preventing our Fed from taking more robust action.
On the bright side, our Fed is leading the world to lower rates and on toward likely recovery. So, if our economic recovery precedes that of other nations, our dollar may be nearing the bottom of an important trough.
I feel the Fed deserves credit for shuffling another small step along the right albeit difficult path, but not the praise it would have earned had it taken a full and necessary stride to lead us towards economic recovery.
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