During a widely anticipated speech in Jackson Hole, Wyoming, last Friday, U.S. Federal Reserve Chairman Ben S. Bernanke acknowledged the ongoing problems in both the housing and asset-backed-commercial-paper (ABCP) markets – as well as quickly spreading global credit crunch. But Bernanke didn’t rush to signal there would be a cut in the benchmark Fed Funds rate, the move that Wall Street has been clamoring for.
It was just what I’d predicted. [For a full analysis of my expectations prior to Bernanke's speech check out my article in Money Morning: “Message to Bernanke: Don’t Give in to Speculative Clamor”]. That said, we must interpret the address at the Kansas City Fed’s annual economic symposium as moving a bit closer to the sought-after rate cut, which is appropriate, since the effects of liquidity and credit dislocation will slow the economy.
[For additional coverage of Bernanke’s comments, and what they mean for the U.S. interest rates and the U.S. economy, look for a Money Morning news analysis that will be posted later today (Monday)].
To Cut, or Not to Cut?
That certainly is one key question: How much of an interest-rate reduction is needed – and how quickly must the Fed act to keep the U.S. economy from experiencing significant distress? The answer, believe me, is not crystal clear… even to Bernanke and the members of the policymaking FOMC Board.
That’s because even they do not know how deeply the current credit crunch is going to hurt the “real” economy, or how quickly any easing of rates will contain – and then counteract – the spreading global fallout from the speculative excesses in the U.S. real estate market.
Current economic data won’t give them much help, and any forthcoming data might lead some to exaggerate their estimates for any projected downturn. Therefore, the Fed will not only be looking at the traditional data – when released – but also at all the real-time evidence in the economy from direct sources, in order to get a handle on what’s really going on.
The economic calendar promises the release of important data in the coming weeks (ahead of the Sept. 18 FOMC meeting), and my prediction is that none of it will be sufficient enough to justify a cut in rates.
This Friday, for instance, we get the latest data on construction, auto and truck sales, the ISM index and – very importantly – U.S. payrolls (the best coincident indicator of economic activity). And during the week of the FOMC meeting itself, the Fed will see core Producer Price Index (PPI) data. But the central bank will not see core Consumer Price Index (CPI) data until the day after the policymakers meet and issue their statement. Hence, it is very reasonable to assume that the available data will not provide the ammunition necessary for the Fed to justify a rate cut at that meeting.
For the Fed to justify a rate cut, they’ll need some alternative economic data from direct sources that points to a clear downward trend in economic activity, as well as in inflationary pressures, especially with respect to prices. But even this data, too, might be unconvincing, so I am less inclined (than the market) to expect any rate cut on Sept. 18. Although I don’t expect a rate cut, I do expect the Fed to change its bias to easing on Sept. 18.
Yet, I still believe that the Fed will act appropriately, on solid evidence, and in a timely fashion, to prevent the economy from going into a recession.
Interest Rates and Investors
Investors should be forewarned of one crucial point: It’s clear to me that “the market” is already discounting a Fed rate cut – and might show disappointment if either:
- The central bank decides not to cut the Fed Funds rates, which is the scenario that I’m predicting.
- Or if some troubling economic data is released in the next few weeks.
In either of these “bad news” cases, you can expect the developments to roil the markets, summoning forth the volatility we’ve grown accustomed to, or even causing share prices too swoon.
So, from an investment perspective, the question is not whether or not to buy the market, but when to buy it, since we are confident about a soft landing, and about the subsequent strengthening of the economy. We should be looking six months ahead – just as the market does.
Therefore, we will continue looking at any weakness as a buying opportunity, and while ferreting out and analyzing these opportunities, I will make sure to maintain an extra-special focus on growth stocks in three key areas.
- Emerging Markets.
The bottom line: The Fed is still not convinced an easing of interest rates is necessary, but they are giving it a much higher probability. That’s entirely proper, and is precisely the stance that I’ve been predicting since these credit issues first grabbed the attention of the investing public.