Thursday, September 20, 2007

Reflection On Fed's Rate Reduction

Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson are scheduled to testify before the House Financial Services Committee at 10:00 AM today in regard to the mortgage and credit markets. After the surprise half-point cut in both the Federal Funds Rate to 4.75% and the Discount Rate to 5.25% at the FOMC meeting, the testimony will be focused on the actions by the Fed as an attempt to give confidence to the credit markets and boost their willingness to provide liquidity. While the effects of the rate decrease will take time to make any real difference in the growth of the economy, the psychological results have been quite visible in the stock market, which has posted significant gains the last two days.

As the actions by the Fed are digested going forward, questions will surface regarding just how bad the economic situation is that it warranted a 50 basis point decrease in rates. Also, if the inflation data is stronger in the next few months, as the rally in gold and oil seem to be indicating, will the Fed be willing to raise rates to maintain price stability, which is their directive. The polar evils of declining growth and increasing inflation are constantly being analyzed by the Fed as they make their policy decisions. With somewhat benign producer and consumer inflation reports in August, it seems Mr. Bernacke chose to make a dramatic move to boost confidence and increase economic growth in the short term. I just hope it doesn't serve to reignite speculative excesses in another asset class.

Meanwhile, more delinquencies and foreclosures can be expected in the subprime, adjustable-rate mortgage market as borrowers face interest-rate resets, according to Federal Reserve Chairman Ben Bernanke's prepared testimony to the House Financial Services Committee today. Bernanke also said that the market for those mortgages has "adjusted sharply," and that markets "do tend to self-correct." He outlined steps the Fed is taking to help reduce the risk of foreclosure and stressed the need to beef up underwriting practices. The Fed chief said he's opposed to raising the conforming loan limit for Fannie Mae and Freddie Mac and said that the central bank stands ready to foster price stability and sustainable economic growth.

The dollar was higher against most major currencies from previous lows, trading at 115.98 yen, down from 116.07 yen in late trading Tuesday. The euro was at $1.3962, down from $1.3977. On the New York Mercantile Exchange, oil remained near $82 a barrel, close to the prior day's intraday record of $82.38. In more recent trading, crude futures were up 54 cents at $82.05, ahead of Tuesday's record close of $81.51. In other commodities trading at the NYME, December gold gained $5.80 to close at $729.50 an ounce. Weakness in the dollar is cited as the catalyst for gold's strength.

US Treasury Bonds and Notes continued their slide, which resulted in higher yields, as inflation fears continued in the wake of the Fed's interest rate cut. The benchmark 10-year note was down 14/31 at 101 25/32, and its yield has risen to 4.526%. As we begin the trading day on Thursday, the DJIA starts off at 13,815.56, while the S&P 500 begins trading at 1529.03, and the NASDAQ opens at 2666.48. After two positive days following the Fed rate reduction, today could result in some profit taking.

John Kaighn

Jersey Benefits Advisors

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