“Traders are just focusing on the Fed.”
– Michael Metz (subscription required), Chief Investment Strategist, Oppenheimer
It’s Fed Day today which means Double B, Ben Bernanke, is in da house baby.
Markets have definitely stabilized since Sept. 18 and the level of fear has come down quite a bit. So this mitigates against the need for another 50 point cut.
Also mitigating against another 50 point cut is gold near $800 and the dollar at all time lows against the euro and a basket of other major currencies. These are market signals of inflation and another 50 point cut creates the possibility of a dollar crisis.
On the other side, housing continues to be a disaster, defaults and foreclosures continue to mount and there are signs that consumer spending is beginning to wane.
The problem with not cutting is that markets have been rallying in expectation of one and no cut would probably result in a huge selloff.
Plus, there is still the problem with housing and some weakness in the economy that might call for lower rates.
That’s why the most likely course of action is a 25 basis point cut.
I think the likelihood of the different scenarios breaks down about this way:
50 point cut: 10% chance
25 basis point cut: 70% chance
No Cut: 20% chance
The next question becomes: How will markets react to each of these scenarios?
If the FOMC doesn’t cut, stocks and gold will selloff badly, and the dollar will rally strongly.
If the FOMC cuts 50, stocks, bonds and gold will explode, and the dollar will tank. One wonders, however, whether stock investors won’t have second thoughts when they think about why Bernanke and the Fed would be cutting 50 at some point.
If the FOMC cuts 25, which seems most likely, stocks will either rally slightly, hold their ground or selloff a bit, depending on the accompanying statement. But there shouldn’t be a big move either way, with more room on the downside.
Gold will probably hold steady and continue its up trend, while the dollar will also hold steady while continuing on its overall downtrend.