5.02.08
For the ninth time since last August 17, the Federal Reserve Bank has announced an interest rate cut, another 25 basis point cut in both the Federal Funds Rate and the Discount Rate. These now stand at 2% and 2.25%, down from 5.25% and 6.25% when the cutting started.
Normally, financial markets, especially stock markets, love central bank rate cuts, as they both lessen the attractiveness of alternative, risk-free investments such as bank certificates of deposit, and they are generally believed to spur economic growth, by increasing the general level of money liquidity in the system. However, in the past few weeks, the markets started to wonder if perhaps they were getting too much of a good thing. The Fed's rate cutting has been particularly fast and furious this year. Starting with big twin emergency 75 basis point cuts in the wake of the Societe Generale trading scandal on January 22, the total amount of cutting in 2008 even before Wednesday's move was 2% in the funds target rate, 2.25% in the discount rate. All the cutting was in response to, and an attempt to ameliorate, the generalized economic weakness spreading out of the financial sector from the subprime crisis. This, of course, was also the rationale behind mid-March's Fed-engineered rescue of the Bear Stearns brokerage house, so as to not drain even more liquidity and confidence from out of the battered financial system.
Looking at the charts, it is hard not to get the impression that the starting bell for this year's precipitous commodity price rises was, indeed, the Fed's first cuts in the middle of January.
Before the January cuts, crude oil was sitting at the bottom of its three-month range, at around US$90 a barrel; this week it topped out at $120, up 33% in three months. Similarly, price rises in corn, rice, soybeans and many other commodities accelerated sharply following the mid-January rate cuts.
The inference here was obvious. With Bernanke's aggressive and repeated interest rate cuts, investors seemed to be more and more concerned that the Fed chairman was sacrificing the fight against inflation in order to more aggressively fight the US economic downturn. Therefore, they were trading their US dollars from a country not seemingly committed to maintaining the value of its currency, for hard, tangible assets such as commodities. The US dollar declined 11.5% against the euro from January 22 to April 22.
US consumers may be grumbling about the higher cost of food but we don’t have the availability crises they are having in different countries which are a matter of life and death. Of the two crises disturbing the world economy - financial disarray and soaring food prices - the latter is the more disturbing. In many developing countries, the poorest quartile of consumers spends close to three-quarters of its income on food. Inevitably, high prices threaten unrest at best and mass starvation at worst.
The recent price spikes apply to almost all significant food and feedstuffs. Yet these jumps are themselves part of a wider range of commodity price rises. Powerful forces are linking prices of energy, industrial raw materials and foodstuffs. Those forces include rapid economic growth in the emerging world, strains on world energy supplies, the weakness of the US dollar and global inflationary pressures.
The weakness of the US dollar is a direct result of lower interest rates. The Fed is now at a point where they can no longer reduce interest rates to help out our economy. Fact is, I don’t believe they should have made the last cut. We pay for Oil with dollars but the producers of the oil want to be paid in their currency which is worth more. We must get the value of the dollar going up. If the dollar can gain 10% in value, it will reduce the price of oil by 40%. The Fed claims that it needs to keep “core inflation” minus food and energy under control. I spend more on food and energy than anything else. Mr. Bernanke needs to get his priorities straight.
We feel that the next move in interest rates will be to the up side. The market does too. We have seen the dollar start to show signs of strength.
Economic activity remains week, household and business spending is subdued and labor markets have softened further. Financial markets are under considerable stress. We also are faced with tight credit conditions and a housing market that will need a few more quarters to start showing any real sings of life. Keep your eye on the value of the Dollar verses the Euro. Strength in the Dollar will be the medicine to cure all the other ills of our economy.
We have issued a BUY signal to the tune of 50% exposure. We are dividing this between the SP500 and the Dow. If we see that the Dollar continues going up, we will add to it.
Till next time
The MTA Staff
