Although it seems likely that Bernanke is making an effort to avoid a cut in the fed funds rate at or before the September meeting, the market may force his hand. First, continuing financial turmoil may make holding the line untenable. Second, a large number of stock market economists and strategists are screaming for a rate cut and the market is long way toward pricing it in. If so, the FOMC may have to cut if only to avoid a severe market collapse following the meeting. The problem is that if a rate cut is already priced in prior to the meeting, the result may still be greeted with disappointment.
In our view, no matter what the Fed does, a major growth slowdown or recession is already baked in the cake as a result of the severe housing decline. Even with today’s 2nd quarter GDP revision, annualized GDP growth has averaged only 2.0% over the last five quarters, and this was before the credit crisis snowballed. In addition 2nd quarter consumer spending was up only 1.3% annualized while employment growth has been tepid. We are therefore faced with a softening economy that can only deteriorate further in the second half. We believe that the stock market rally since the bottom is purely technical and that much more decline is ahead!
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