Ramsey
31-10-2002, Thu 8:35 PM
Oct 31 12:15PM : Can the Fed Help the Dow and Dollar Rally? Part I
Currency traders have had to keep one eye on Wall Street lately, as the gyrations in US asset markets remain the best proxy for dollar sentiment. Wednesday's Fed decision is going to make waves in the stock and bond markets and should hold sway over the buck. History shows the dollar usually gains from lower rates. But if the Dow and dollar rally in anticipation that the Fed will ease next week, it s a recipe for buy the rumor, sell the fact because any further cut would be ineffectual without improving economic fundamentals in place. Therefore, the bigger question is whether or not this rally is for real, because if its not, traders are likely to mimic the dour mood on Main Street and begin selling the dollar again.
The dollar slipped on today s rise in jobless claims and below forecast 3.1% gain in Q3 GDP. Immediate focus remains on the jobs report and ISM survey tomorrow, but the main event is next Wednesday s Federal Reserve monetary policy meeting. Currently, futures are pricing in an 85% chance of a 25-basis point cut, from the 40-year low of 1.75%. Traders feel pretty confident in a cut because the economic data is so poor. But the market is likely to be disappointed since the Fed lowered rates eleven times last year and one more is not going to help.
In fact, while rate cuts are normally seen as benefiting stocks, the "Don't fight the Fed" mantra has not produced anything but a bear market rally in this downturn. Greenspan's impotence is most telling in the recent consumer confidence surveys that have plunged to 9-year lows. Although this same survey was used as justification for a "V-shaped" recovery during the October 2001-March 2002 rally, some have already written off the Conference board's massive decline. But the University of Michigan's index showed identical weakness and is now sitting on trendline support of a 20-year bullish channel. A fall from here would not only mark new multi-year lows, it would also imply that consumer confidence has reversed from a 20-year bull run, a significant psychological development which would likely be a further drag on the economy. Moreover, the employment component of these surveys points to a deterioration in jobs availability while the falling expectations figure could be a drag on spending in 2003. It may be one of the mildest recessions on record, but it will get ugly if consumers reign in their purchases - even a little bit.
This environment puts the Fed is in an uncomfortable lose-lose situation where a rate cut won't help the main drag on growth which is new capital investment by businesses, while inaction will be met by ire. If a manager has not already decided to invest, another 25 bp isn't going to change his mind. On the other hand, if Greenspan and Co. does not cut rates, it may push Wall Street into another nasty selloff. In a further complication, if the Fed uses a cut now and the economy doesn't turn around it will be regarded as wasted ammunition if another terrorist attack or war in Iraq threatens to derail the national psyche.
The greatest risk to the market is not the Fed s decision on rates, but the constant deterioration of economic fundamentals, which will weigh on earnings growth and force prices down until a more normal P/E ratio is reached. This fundamental norm remains the biggest nemesis to market bulls and by most technical indicators the rally from October's 5-year lows is already showing signs it won't last.
Currency traders have had to keep one eye on Wall Street lately, as the gyrations in US asset markets remain the best proxy for dollar sentiment. Wednesday's Fed decision is going to make waves in the stock and bond markets and should hold sway over the buck. History shows the dollar usually gains from lower rates. But if the Dow and dollar rally in anticipation that the Fed will ease next week, it s a recipe for buy the rumor, sell the fact because any further cut would be ineffectual without improving economic fundamentals in place. Therefore, the bigger question is whether or not this rally is for real, because if its not, traders are likely to mimic the dour mood on Main Street and begin selling the dollar again.
The dollar slipped on today s rise in jobless claims and below forecast 3.1% gain in Q3 GDP. Immediate focus remains on the jobs report and ISM survey tomorrow, but the main event is next Wednesday s Federal Reserve monetary policy meeting. Currently, futures are pricing in an 85% chance of a 25-basis point cut, from the 40-year low of 1.75%. Traders feel pretty confident in a cut because the economic data is so poor. But the market is likely to be disappointed since the Fed lowered rates eleven times last year and one more is not going to help.
In fact, while rate cuts are normally seen as benefiting stocks, the "Don't fight the Fed" mantra has not produced anything but a bear market rally in this downturn. Greenspan's impotence is most telling in the recent consumer confidence surveys that have plunged to 9-year lows. Although this same survey was used as justification for a "V-shaped" recovery during the October 2001-March 2002 rally, some have already written off the Conference board's massive decline. But the University of Michigan's index showed identical weakness and is now sitting on trendline support of a 20-year bullish channel. A fall from here would not only mark new multi-year lows, it would also imply that consumer confidence has reversed from a 20-year bull run, a significant psychological development which would likely be a further drag on the economy. Moreover, the employment component of these surveys points to a deterioration in jobs availability while the falling expectations figure could be a drag on spending in 2003. It may be one of the mildest recessions on record, but it will get ugly if consumers reign in their purchases - even a little bit.
This environment puts the Fed is in an uncomfortable lose-lose situation where a rate cut won't help the main drag on growth which is new capital investment by businesses, while inaction will be met by ire. If a manager has not already decided to invest, another 25 bp isn't going to change his mind. On the other hand, if Greenspan and Co. does not cut rates, it may push Wall Street into another nasty selloff. In a further complication, if the Fed uses a cut now and the economy doesn't turn around it will be regarded as wasted ammunition if another terrorist attack or war in Iraq threatens to derail the national psyche.
The greatest risk to the market is not the Fed s decision on rates, but the constant deterioration of economic fundamentals, which will weigh on earnings growth and force prices down until a more normal P/E ratio is reached. This fundamental norm remains the biggest nemesis to market bulls and by most technical indicators the rally from October's 5-year lows is already showing signs it won't last.