Navarro's Big Economic Picture
Inside the Fed's Thinking

Last week, I gave you four good reasons why the Fed would only lower interest rates by 25 basis points. So here’s what we are going to do this week. I am going to faithfully reproduce those reasons and then provide comment related to the Fed's actual decision to lower short-term interest rates by 50 basis points.

Before I do that, let me say that I think Bernanke got it exactly wrong, and the comments below will provide reasons as to why that may be true. Clearly, the “Bernanke Put” is alive and not so well because no stock market can thrive over time if the Federal Reserve is always ready to bail out speculators.

Here then are the four reasons and my comments:

#1: A 50 basis point cut might backfire because it would signal that recession fears are far more serious than the Fed has had us believe.

COMMENT: This remains the big danger. One week does not a market rally make on this news.

#2: One of the biggest dangers of cutting interest rates is further downward pressure on the dollar. Lower interest rates lead to increased capital outflows, weakening the dollar. While a weak dollar might help exports and our trade deficit, it would also be inflationary.

COMMENT: Sure enough, the dollar plunged on the Bernanke move. It has now hit a 15 year low. Pretty soon, we’ll be using it for toilet paper.

#3: While recent data is indeed suggests growing softness in the economy, the recession signaled is not yet clear or strong enough to warrant a big rate cut. The danger of any such cut if the economy isn't as soft as people believe is more inflation.

COMMENT: The stock market rallied on the news, suggesting that the economy is indeed a bit stronger that the Fed is thinking. Worst still, long bond rates rose, signaling inflation, which is my chief concern.

#4: There is really no hurry in cutting rates. If another cut is warranted, it can be done in the next month, and another cut after that, and so on. Ben Bernanke is above all a gradualist.

COMMENT: This move was more in keeping with Helicopter Ben and ultra-easy money.

FINAL TAKE: The Fed doesn’t set “interest rates.” It only sets short term interest rates. The bond market’s reaction to the Fed determines long term interest rates. It looks like the market is betting on higher interest rates on the long end, so this effectively neutralizes the Fed stimulus, at least for the housing market, because mortgage rates will rise not fall!!!!!!

This Week's Big Market Movers

It is a pretty quiet week for economic reports. The only two with the capability of moving the markets are likely to be existing home sales on Tuesday and new home sales on Thursday. Any big further drop-off in the housing sector is clearly bearish.

Given the dearth of economic reports, it is more likely that a slew of earnings reports will prove to be the most important fodder for the market to vamp on. I'm not concerned so much year with any one company's report but rather what the pattern is. So far, earnings have been better than expected which is bullish.

Trade of the Week - 

According to Yahoo Finance, “Discovery Laboratories, Inc., together with its subsidiaries, operates as a biotechnology company that develops proprietary surfactant technology as Surfactant Replacement Therapies (SRT) for respiratory disorders and diseases. “ Buying this stock now is exactly getting in at the bottom as this penny stock has had a nice run over the last month or so. However, its technicals look very good and suggest that there is something very good going on fundamentally with their drug pipeline. This is strictly a high-risk venture. However, as penny stocks go, it's not a bad risk-reward.

The International Scene - Technical Take

The week offered some additional improvement from last week. Europe, Australia, Korea, Latin America, and Brazil ETFs all went into the neutral or buy category. The battle for the hearts and minds of investors is growing more complicated.

*Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.

“Any trader or investor who ignores the power of macroeconomics over the world’s
financial markets will, sooner or later, lose more than they should—and if they are
trading on margin, perhaps more than they have.”
 -- If It's Raining in Brazil, Buy Starbucks

The Market Edge Market Summary from www.marketedge.com 

CONTACT INFORMATION
Peter Navarro
Irvine, California USA
Email  |  Website

DISCLAIMER: This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever. Trading and investing involves high levels of risk. The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The authors may or may not have positions in the financial instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future performance.