With all the fear that exists in the markets today, it seems all the world is waiting on what Mr. Bernanke decides to do with the Fed Fund Rates on Tuesday.
1) No rate cut
2) 25 bps rate cut
3) 50 bps rate cut
After running each scenario through my mind a few times, I looked at what each potentially signifies to the market, and concluded that none of the above have ideal outcomes.
If the explanation for a rate cut is saving the housing market—think again; 25 or even 50 bps will have a minuscule effect on the mortgage and housing markets. It is a buyers market, but there is much more supply than demand, and housing will continue to falter regardless of Tuesday’s decision.
A rate cut could also send a message to the market that the Yen currency carry trade is winding up and could send the Yen appreciating versus the dollar and all major currencies once again. Let me rationalize that thought quickly: a rate cut, while it will have the obvious effect of lowering the interest rate differential between the Dollar and Yen, would allow Japanese investors, who have fled Japan in the hopes of generating additional returns abroad in the equity markets, to exit their positions. They will exit their positions because of the short-term run-up in US equity prices from a rate cut and transfer their money back to Japanese Yen, causing further appreciation of the Yen. Thus, another liquidity source would be drained.
No rate cut will be seen as a sign of an unwavering Ben Bernanke standing in the way of a thousand Red Coats—I mean Wall Street executives—looking for blood because they want their equity investments to shoot up in value before the end of the quarter from a rate cut. Expect equities and fixed income securities to take a beating if the rate stays the same, but you can expect foreigners to stay invested here in the United States.
Gauging the market’s activity over the past couple weeks, there will be a rate cut of 25 bps on Tuesday, although it might not in the best interest of a stable US economy. The 25 bps cut will instead have a negligible effect on the economy and will symbolize to the world that the United States is gearing up for a recession. However, it all rests on Bernanke’s shoulders, so we’ll all just have to wait and see what stance the Fed wants to take to combat the current conundrum.
