Monday, December 10, 2007

No rate cut tomorrow?

It would be interesting to see the reaction if the Fed left interest rates unchanged tomorrow. There would be a sell-off by the short term traders at first, and it might be unsettling. The follow through over the next few days could be surprising, and reassuring. An indication of support for the dollar by the central bank could help the bond market, which at times in recent months has had the upper hand in influencing equity prices. At some point, in these global financial markets, holding firm could stabilize the import/export equation. If continued deterioration of the dollar due to interest rate reductions creates fear overseas that the U.S., their biggest trading partner, is either paying for goods with a less valuable currency or turning to domestic products because the dollar isn't buying as much...It becomes what the old economics textbooks called a "beggar thy neighbor" situation. The U.S. struggles to avoid a downturn and creates ones elsewhere.

Why, one could ask, waste time on such speculation that the Fed will do, or has the leeway to do, what would in the long run be the best course of action. The real issue driving the Fed is market liquidity, and the fact that credit markets are still functioning in second gear. A quarter point, a half point, that's not going to change the plight of U.S. consumers caught up in credit problems any time soon. It will, however, add grease to the mechanics of the credit markets for big financial institutions and corporations, which over time supply money and jobs to the economy.

Here's the deal right now, why 25 basis points will likely happen and why 50 basis points is not ruled out here. Year end, as in December 31, is the end of the fiscal year for most large financial companies and for corporations. In credit market times like these there can be a scramble for access to money at this point, as banks, asset managers, real estate firms and others need adequate capital and liquidity for their balance sheets. That may sound cosmetic, but the market thinking is if a company can't get what it needs there is either a problem with planning, at best, or the business, at worst. Debt ratings, credit lines, the stock outlook can all be affected. The Fed does not want to risk a credit market crisis or seize up at year end. It will put the dollar at further risk now, and firm up in 2008.

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