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Fed Interest Rates
The Smart Profits Report: Issue #476
Wednesday, November 28, 2007
Fed Interest Rates: Depressed Economy, Inflation Fears & A Weak Dollar Present Problems For Fed
By Martin Denholm
Managing Editor, Mt. Vernon Research
Now here’s a fella who likes soundbytes…
He wants to “unclog the plumbing of the financial system.” He wants a “shock-and-awe” Fed interest rates cut to give the U.S. economy and stock market a “huge shot in the arm.” In short, he wants Ben Bernanke and his band of bankers to get really tough and slash interest rates by 1%.
Who the heck is this guy? Jim Cramer? Santa Claus? Clearly, he doesn’t care too much for savers. And as for the U.S. dollar… forget it. Let it tank some more and make it even easier for foreign companies to buy American ones.
Step up, John Ryding, Chief U.S. economist at Bear Stearns (NYSE: BSC), quoted in an interview with BusinessWeek. Does he have a point, or is he completely nuts?
The Stock Market’s 3-Month Bluff
Historically, the worst time of the year to own stocks is September-October, but after sprinting through the fall en route to new highs for the year, the market has simply bluffed giddy investors and lulled them into a false sense of security.
Those who expected stocks to just keep rising have had a seriously rude awakening. As I write, the Dow Industrials are down 7.2% in November, the Nasdaq Composite has shed 9% this month, while the broader S&P 500 is down 7.7%.
Turns out the subprime mortgage meltdown and credit concerns weren’t done with the market, though. And having once basked in the investment world’s warm glow, many banks both in the U.S. and across the world have had to ‘fess up and admit their mistakes, writing off billions of dollars.
I don’t have to say much about the other factors weighing on the economy and stock market: Oil prices racing to $99; gasoline prices at $3.11 a gallon (national average); home energy bills rising; the real estate market in full-on correction mode. Just in time for Christmas, too.
So can the Fed ride to the rescue? And more to the point, should they?
Fed Interest Rates - A 0.25% Cut
The bankers’ final monetary policy meeting of 2007 is set for December 11 and right now, the consensus is that they’ll cut interest rates again, by 0.25%.
This wouldn’t be a great surprise, given that the minutes of the October 31 meeting showed that the Fed saw “substantial downside risks to the economic outlook.” It backed that up last week, slashing its U.S. GDP growth forecast next year from the 2.5%-2.75% range in July to 1.8%-2.5% now, and projected a rise in the unemployment rate from 4.7% in October to 4.9% by Q4 2008.
But predicting the Fed’s moves can be a tough task. The board also thought that the 0.25% October cut, in addition to the 0.5% chop in September, would be enough to fire the economy into life and ease the credit and housing market concerns.
But although all-but one of the bankers voted for the cut, it was still a “close call” amid fears that inflation could easily rise. And recent Fed rhetoric seems to imply that it would rather not cut rates again, and doesn’t want the market to assume that it will do so at the first sign of trouble.
Both Chicago Fed President Charles Evans and Philadelphia Fed President Charles Plosser don’t want another rate cut on December 11, with Plosser today stating: “The markets will have to figure this out. Arbitrarily lowering interest rates or providing liquidity to the market does not provide the answers the market seeks.”
And there’s a big reason why…
Cuts To Fed Interest Rates Are Weakening The U.S. Dollar
The Fed can cut interest rates as much as it wants to, in order to pump some liquidity back into the markets and spark the economy - and it might make investors happy for a while - but in doing so, they risk twisting the knife into the U.S. dollar. Since early September, the Dollar Index has traded under the key 80-point level, with many of the world’s major currencies hitting multi-year or record highs. And each rate cut serves to weaken the dollar’s attractiveness to foreign investors.
What’s more, a weak dollar increases inflationary pressures via commodity prices. Policymakers believe a 1% drop in the dollar equals a 1% rise in oil prices. This has a domino effect, with speculators ditching the dollar in favor of oil and driving the price up for consumers.
Hardly surprising then that it’s a delicate balancing act for the Fed. And it pretty much kills John Ryding’s hope for that “shock-and-awe” rate cut.
European Commission President Jose Manuel Barroso has admitted that the weak dollar poses a problem not just for the U.S., but the rest of the world, with the high euro potentially hurting European exporters. And speaking of the rest of the world…
The Weak Dollar May Spark Foreign Corporate Acquisitions
The low dollar, relative to other major currencies, has also sparked a run on American companies from foreign counterparts. Through the first nine months of the year, the value of U.S. corporate acquisitions from overseas firms hit $257.4 billion, according to Thomson Financial. That’s the highest since 2000.
And it’s more than just acquiring a company. If the trend continues, some are concerned that in addition to Americans losing their jobs, America’s corporate power and independence will diminish, as more foreigners will gain access to the most lucrative, dynamic sectors like technology.
This is a good time to evaluate your portfolio’s diversity and exposure to foreign markets. In the December Xcelerated Profits Report issue (sent to subscribers yesterday afternoon), Investment Director Karim Rahemtulla quoted a statistic from Grant Thornton, who state that by 2050, the so-called “BRIC” nations (the emerging markets of Brazil, Russia, India and China) will account for 44% of global GDP. Make sure you capitalize on the trend.
Best regards,
Martin Denholm
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Today’s Smart Profits Action Center
- It wasn’t a buyout… but it was the next best thing. Having been kicked around the Street for weeks, battered and bruised Citigroup (NYSE: C) today received a much-needed cash injection from the Abu Dhabi Investment Authority. The group pumped $7.5 billion into Citigroup in a show of confidence in America’s largest bank and the beaten-down financial sector. The move now makes it Citi’s largest shareholder. Citi’s success in attracting this investment sent the Dow Industrials up 215 points today and boosted Citi’s financial sector competitors on hopes that they may also be able to raise capital. And of course, a weak dollar makes such investment more attractive for foreign firms.
- Far from running for the exits with ordinary investors, the Xcelerated Profits Report team views the recent market meltdown as a chance to buy great companies at much lower prices. That’s exactly what Investment Director Karim Rahemtulla and technical analyst Jim Stanton have done in the December issue. In fact, like the Abu Dhabi Investment Authority, they’re also investing in the financial sector. To find out how easy (and cheap) it is to receive profitable recommendations from professional traders every month - who are so confident in their picks that they guarantee an 80% win rate on your trades - click this link.
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