A couple of weeks ago I speculated that we may come to a point where the Fed cuts rates but then the market realises that the economic outlook is poor, leading to further market declines. The probability of this scenario occurring appears to be rising. The Fed looks like it will cut later this month but it will cut because it is concerned about the economy, not because it wants to prop up asset prices. In fact, from the snippets of Bernanke’s speech I have read, the Fed is becoming very concerned about the economy. It realises that falling housing prices will probably impact consumer spending. It also realises that credit conditions are tightening, and lower interest rates are needed to neutralise that impact, and possibly reverse it.
But all of this does not really matter. Why? Because the Fed is behind the curve. If there is going to be a recession later this year, or early next year, the Fed is already too late. Monetary policy operates with long and variable lags. All the Fed can do is try to ensure that any upcoming recession is not too long or too severe. I think the Fed knows this too.
MARKET POSITION: SHORT (4 units)
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