As Of: April 18, 2001
The Fed Cuts Rates
It is hard to avoid asking why now?
There are two reasons why the Federal Reserve cuts interest rates: 1) Lower interest rates affect the fundamental structure of the economy, and 2) An interest rate cut is a signal that the Fed is "on the job" and provides a psychological boost to consumers, investors, employers, in fact virtually everyone who has any vested interest in the economy. When the Federal Reserve acts to lower interest rates between regularly scheduled Open Market Committee meetings, it is very important that the move receives a positive reaction in order to preserve the credibility of the Federal Reserve. The next regularly scheduled meeting is on May 15th. The fact that the Fed cut rates today has to be seen as a carefully orchestrated, almost Machiavellian, move designed to ensure that the stock market will record a large gain, and ensure that the cut will receive positive mention in the media reinforcing the view that Alan Greenspan is doing his job to rescue us from a recession.
Why was today chosen? 1) The Treasury futures market had priced out the possibility that there would be an intervening cut. The element of surprise was on the side of the Fed. 2) There was a lot of talk in the stock market that a bottom was in place and the market should go up from here. In the past week, the NASDAQ composite Index had already moved up from 1638 to 1923 (a 17.3% increase). Momentum was already in place for the market to continue up. 3) The market was getting an extra push up today on the heels of a good earnings report from Intel. 4) It was becoming evident that short-sellers were being squeezed by the upward momentum of the market. Investors who are short have to turn around and buy back their positions. This puts even more upward pressure on the market. 5) We are right in front of an option expiration. A short squeeze exacerbated by the need to close out option positions puts an incredible pressure on traders.
So the Fed cleverly engineered a huge market rally today, which theoretically boosts their credibility. Yes, we have been shown again the power of Alan Greenspan. And we should be pleased and relieved that he is using his power to stimulate the economy and make life better for all of us. But the question remains, why couldn't he wait until the regularly scheduled May meeting? Does the Federal Reserve fear that things are not going well with the economy and an extra stimulus is necessary? It would appear the answer is yes.
On the one hand it is good that the Fed is trying to stimulate the economy. On the other hand, it is probably too little too late. The Fed can engineer dramatic stock market bounces, but that doesn't fix the economy. An interest rate change usually takes months to flow through the economy and have a real structural effect. In spite of the excitement in the stock market today, we probably have a long period of weak economic performance ahead of us before a real turnaround is at hand. Therefore, stock investors should not be fooled into chasing a sucker's rally. For the quick and nimble, short term rallies are wonderful. However, long term investors should not be distracted by short term events. My earlier article on P/E ratios that explains why there is a major revaluation going on in the stock market still holds true. And my advice about dollar cost averaging through this long term correction in the market still holds true. Days like today place a lot of pressure on investors who think they are missing the move, but the fact is the move was missed if you didn't have your positions in place a week ago when prices were substantially lower. There will be other dips in the future, and that is the time to buy. The recession was not canceled today. At best it was just shortened a little, or made a little less severe. We still have a long way to go before you can be confident that stock prices will continue up in a straight line. So be patient and pick your entry points carefully.