Tags: Rate Cut, Stock Indexes

U.S. Fed Readies Itself For All the Right Moves

By , Contributing Editor, Money Morning •

As we await the announced decision of U.S. Federal Reserve policymakers today, there are some very important facts to keep in mind.

First and foremost is this: The fears of a recession are highly exaggerated. The U.S. economy has good momentum, the American consumer is still spending, and we believe that central bank will reduce rates this afternoon.

Rate Cut Expected

Indeed, I'm anticipating that the central bank's policymaking Federal Open Market Committee (FOMC) will announce a reasonable, but still conservative, quarter-point reduction in the benchmark U.S. Federal Funds rates. That should be enough to reassure consumers and investors, but won't be so much that it ignites actual inflation or fuels potentially ruinous speculation that the central bank is catering to bailout-seeking speculators.

Another key factor to consider - both because it buttresses my argument that the economy is healthy, and also because it represents a terrific investment opportunity - is that this is the seasonal upside for the high-tech sector. We've already seen sales figures indicating that sales of PCs, notebook computers and Internet servers have all been better than expected. Top-tier companies such as Apple Inc. and Advanced Micro Devices are launching new products, which is good because it attracts attention, which in turn spurs additional profit-boosting sales for the whole industry.

The tech sector is already healthy. A rate reduction - even a small one - will help fan the flames of industry growth, profitability, and additional product development. That latter point, in turn, can help fuel capital investments by the business sector, since companies like to keep their technological base as current as possible to remain as competitive as they can. New products attract just that kind of spending.
And all that, of course, in turn helps fuel job growth. And that's a good point to understand. But there are a number of factors to consider, some of them quite contradictory, it seems. Let's look and see what I mean.

Conflicting Reports

Two Fridays ago (Sept. 7), investors were stunned by a "shocker" jobs report that fell so far short of expectations that it made it appear as if an interest rate cut were fait accompli. Unfortunately, the report was so dismal that it also touched off fears of an outright recession - and sent the Dow Jones Industrial Average careening downward by nearly 1.9%, or 250 points.

This past Friday (Sept. 14), the headlines weren't nearly as dire. Indeed, the headlines on this past Friday's retail sales actually confirmed the resilience of the U.S. consumer - in spite of the apparent weakness in the numbers: Retail sales were up 0.3%, but down 0.4% excluding autos. Many analysts missed the fact that gasoline price drops subtracted 0.6%, which is hardly negative for the consumer. In fact, just the opposite is true. And chain-store sales came in strong.

That was enough to put the market on hold as it awaited today's interest-rate decision by the FOMC. In fact, blue-chip stocks actually gained 2.5% for the week, making it the best week for the bellwether Dow since April.

Now, what about the Fed?

All the Right Moves

Although policymakers have a number of possible options before them, the economic realities essentially limit the FOMC to two choices, neither of them cure-alls for the business and economic problems the U.S. economy faces. The Fed can:

  • Lower rates preemptively - in anticipation of an economic slowdown - on the basis of one bad unemployment number and the possible effects of a liquidity crunch, or ...
  • Hold off on any move at all in the face of the renewed inflationary expectations evidenced in the price of gold, oil, wheat and other commodities, as well as in the low value of the U.S. dollar.

In addition to the factors I've already outlined, Fed policymakers have these other issues to consider.

Gold and oil are near all-time highs in nominal (not inflation-adjusted) prices. Many market players have taken refuge in U.S. Treasuries, in certain commodities and in other currencies in the face of the ongoing global credit crunch. Should the U.S. dollar remain weak for a long period, oil prices could eventually filter into core inflation.

In addition, we've had news of accelerating inflation in China, with a report showing that consumer prices rose at a 6.5% rate over the past 12 months. China's economy is accelerating, to the point that the World Bank just increased its GDP estimate for this year from 10.4% to 11.3%. The Chinese government raised interest rates another 27 basis points, which is too-little/too-late and will slow neither growth nor inflation. The still-undervalued currency keeps attracting loads of foreign flows. And cash is flowing into equities and real estate, boosting further economic growth. What's important is that import prices from China are up 0.3%.

The Bottom Line

A prudent mid-course compromise is warranted, and we are strongly inclined to expect a quarter-point rate cut.

That will initially disappoint investors, and we'll see a near-term drop in major stock indices.

Use that as a buying opportunity to pick up any high-quality shares that you've been watching, but haven't wanted to buy.

Related News and Story Links: