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“Weakness in the equity market has been significant, and the economic numbers have been poor. The Fed has to respond."
Goldman senior economist Jan Hatzius. August 6, 2002
Despite pleas from Mr. Hatzius and other Wall Street commentators the main reason why the Fed will probably leave interest rates alone this week is because a cut could have a negative psychological impact on the markets. To be sure, in recent weeks no Fed member has been warning that the economy may slip back into recession and no set of economic numbers has been so explicitly bad as to suggest the economy needs immediate help. Point being, the Fed has not prepared investors for a cut: unless the Fed cuts inter-meeting members tend to hint that a rate move is coming beforehand. Moreover, even though the economy has shown signs of weakness there has not been that one truly ugly report which scares everyone and sends the markets crashing lower (in fact, the markets have actually firmed since the worst numbers have arrived). In sum, a Fed cut now has the potential to undermine the significance of last years 11 cuts and make investors increasingly skeptical that the recovery still has legs.
That said, the Fed is likely to change its statement and warn of the possibility of economic weakness. They would remiss if they did not. Thus, the question is:
How does the Fed leave interest rates alone and still provide a 1 sentence warning of economic weakness without startling investors?
There is no easy answer to this question. In fact, if the Fed’s comments suggest that the U.S economy is at risk of entering another recession and they leave interest rates alone this could be an extremely negative development – perhaps even more dangerous than cutting interest rates…
With these things in mind, no matter what the Fed does the stock markets could be in trouble. Remember that the Fed will be telling everyone this week, either by way of their actions or words, that the risk of economic weakness has risen. This is bad news whether the overnight lending rate is at 1.75%, 1.25%, or even 0%. Moreover, this is bad news regardless of whether the markets can rally in the near term or not.
You could say investors are thinking about the proverbial double dip but few are convinced (even Morgan’s Roach, the most notable double-dipper, sees only a 60-65% chance of a double dip.) Suffice it to say, it will have been an astonishing week if the Fed’s words and/or actions help reduce double dip speculations.
CEOs and CFOs To Certify
Following the Fed statement the SEC ‘certification’ deadline looms. Although this event has captured the headlines in recent weeks few people seem to be talking about how the SEC language still leaves room CEOs to use ignorance as a defense. It may take a few months or years, but once the hoopla surrounding August 14 subsides and a CEO makes a mistake, only then will new certification rules be put the test.
Other
July retail sales, July Industrial production, August Philli Fed, July CPI, and August Mich. Sentiment (consumer confidence) are some of the reports due out this week. Will CPI confirm that deflationary pressures are rising? Will the Philli Fed confirm that manufacturing is still weak? Will Mich. Sentiment rebound from July?
Regardless, options expiration on Friday may help confirm that volatility is here to stay.
All data and information within these pages is thought to be taken from reliable sources but there is no guarantee as such. All opinions expressed on this site are opinions and should not be regarded as investment advice.
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FallStreet.com
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