Will A Fed Rate Cut Really Help?

Source : The Business Times, September 10, 2007

MARKETS

SOME 5-6 weeks ago when the US Federal Reserve and various other central banks injected liquidity into the finacial markets to prevent an all-out collapse, we pondered the question of whether such central bank intervention was only delaying the inevitable.

Since then - and because the intervention did not have its desired effect as stocks continued to slide - Fed chief Ben Bernanke dropped prominent hints that his organisation would do whatever is necessary to ensure the US does not slip into a recession.

Coming soon after the Fed cut its discount rate two weeks ago, these comments have been widely taken to mean that a possibly aggressive federal funds rate cut is on the cards at the Sept 18 Federal Open Markets Committee (FOMC) meeting.

In other words, Wall Street has known for several weeks now that Fed action is probable to stave off a financial disaster. Despite this, stocks have continued to come under pressure.

Or to be more precise, stocks have not performed despite every one (well, almost every one) being confident that Mr Bernanke and his colleagues will bow to political pressure and help keep the liquidity ball rolling.

Of course, markets are rarely if ever that efficient in discounting expectations and perhaps several weeks is insufficient for sentiment to be fully restored to pre-July levels.

But one can't help but get the nagging feeling that even if US rates are cut on Sept 18, the relief it affords might only be temporary.

On Friday, Wall Street collapsed after the release of a dismal jobs report, the worst since 2003. According to the New York Times, most of the job losses came not surprisingly in construction and housing, and according to economists it interviewed, this raises the probability of a US recession next year to as high as 25-50 per cent. Add to this rising oil prices and slowing consumer spending and it's not difficult to see how this conclusion has come about.

It appears Friday's action all but guarantees that the Fed will cut rates on Sept 18 and some observers are hoping for a 50 basis points reduction from 5.25 to 4.75 per cent. Indeed, it's very likely that the Straits Times Index's outperformance last week - it shot up almost 100 points, or almost 3%, over the five days even as regional majors Japan and Hong Kong faltered - was due to hedge funds positioning themselves for the post-Sept 18 rally that everyone is hoping for.`

In fact, some observers believe that a rate cut before Sept 18 is possible - DBS Group Research for example, said over the weekend that a 25 points cut on Sept 18 is a done deal and that there really is no reason to wait until then to implement it.

Our guess is the same as it's been for some weeks now, namely that the smart money would probably take the opportunity to sell into strength post-rate cut, raise cash and withdraw for the time being until the dust fully settles on the sub-prime fiasco. It may take a few more months but patience will surely pay dividends.

If the Fed does cut rates by 50 points then the relief afforded might last a little bit longer than a 25-points cut, but our guess is that it could fizzle out quickly, especially if the economic numbers continue to be weak.

Meanwhile, it looks like house traders and syndicates, having made a lot of money pushing loss-making penny stocks throughout April-July and having sold out at the top are now ready to renew their activities again. And why not?

This is a market that thrives on inside information, rumour and the ability of 'operators' (a polite alternative to 'manipulators') to move stocks with or without the aid of corporate insiders.

Moreover, as far as the retail hordes are concerned, this is what investing is all about since it usually results in large gains in a short space of time. The advice again is the same - a US rate cut could help keep the momentum going but traders should be aware there's a good chance it won't last too long.