The Sure Thing

Two major articles last week – both by journalists with ties to the Fed – announced that the FOMC would be cutting rates this week for the 13th time this cycle. The dueling articles each came to a different conclusion about the size of the cuts, with the Wash Post predicting a half point, while the WSJ expecting “only” a quarter point move.

The only surprise would be if the Fed did nothing, which we believe is all but impossible. The yield on the two year treasury note fell below the Fed funds rate; This invariably foretells a rate cut. The Fed fund futures are also saying a cut is a “Sure Thing,” pricing in a “100 percent probability that the FOMC will lower the target rate by at least 25 basis points from 1¼% to one percent, and a 52% chance of a ½ point cut” (percentages based on June 20th closing prices).

With all these factors suggesting an imminent rate cut, it behooves us to consider what the market’s reaction might be. Is this an insurance cut, as some Fed members have suggested? Or, is it a sign that the Fed is getting nervous? As previously mentioned, I believe this cut is part of a broader attempt to crank GDP up over 4%, in an effort to start creating jobs. Presidents do not get re-elected nor Fed Chairman reappointed when the economy continues to shed workers at the alarming rates we’ve seen the past 3 years.

There is also a danger in misinterpreting the market’s reaction to the Fed’s decision Wednesday at 2:15pm; The markets have been quite overbought for some time now, and a variety of our favorite indicators have suggested that a modest pullback is way overdue. There is a danger in misreading the meanderings of the markets as a vote of confidence (or not) in whatever the Fed does.

Greenspan has long been thought of as a gradualist; As the chart at right makes clear, he has brought rates down over the course of 2½ years. Investors may be best served by considering the Fed’s next move as the last in this very long series of interest rate adjustments, as opposed to over interpreting the significance “Lucky 13.”

The rally (which began on March 12) has gotten a bit ahead of itself; This suggests those who are already long should consider tightening up their stops; We will look at where the downside leadership may come from later this week. Those looking for an entry should consider scaling into equities as the Dow approaches support at 8,900-9000, the S&P 500 between 950-960, and for the Nasdaq from 1,550-1,565.

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