Monday, October 1, 2007

Monday, Monday

"We are two weeks into a rate-cutting campaign of unknown duration. Right now the market is pricing in a Fed Funds rate of about 4.15% for late next year, so it's looking for 2-3 additional 25bps rate cuts, including one likely to come at the October meeting. I think this is a conservative estimate -- no matter what the Fed does, housing is likely to stay bad for the next year, the job market has just started to turn, plus financial markets may need additional bailouts -- plus 2008 is a critical presidential election year. All important constituencies will want additional rate cuts. The only reason not to cut rates steeply? Dollar stability, which the Fed, by cutting 50bps already, has shown is not a major priority on their agenda.

In the past, rate cuts have led to either stock market or housing market gains, but the unstated assumption there was that the dollar and the interests of dollar/bond-holders were non-factors. This time around, I believe that assumption will be false. Since the rate cut, the dollar has fallen 2.5%, the 10-year has risen 0.12%, gold has risen 3.8%, and crude oil has risen 1.5%. This has taken the dollar to all-time lows, and gold and crude to all-time highs. Long-term interest rates remain near all-time lows -- given the previous sentence, does that make sense? The question is will foreign dollar/bond holders tolerate a weakening US currency, and will Americans continue to buy the 2% core inflation story with gold at $1000 and crude at $100. If 2007 were the year of subprime, 2008 will be the year of the dollar and central bank standoffs. So if you want to know where stocks are going to go, pay attention to interest rates in the US, Japan, and Europe. Pay attention to gold and crude. Pay attention to overnight LIBOR rates. Pay attention to wheat, corn, copper, and nickel. These will be the drivers of the economy, not earnings from Google or Goldman Sachs, or statements from the Fed." - From Conor @

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