Well the week ended quietly with stocks finishing slightly red for the most part. I think there is a lot of data that the market is trying to digest right now.
You have energy stocks that continue to soar as oil rises which is helping to hold up the DOW.
The horrible news regarding the consumer and housing is putting downward pressure on the DOW via financials and the retail/consumer stocks. The end result is a pretty flat market.
We have been trading this way for most of the week. The big question the market is now asking itself is what are oil and the dollar going to do going forward?
The Fed interest rate policy going forward is going to affect this trade. It will be reaction of the speculators that you need to look at. The Fed interest rate changes pretty much mean nothing now from a borrowing perspective because the banks don't want to lend.
The Fed is not helping liquidity for the average home buyer because interest rates are no longer reacting to the cuts.
The only effect the rate cuts have are on savers and the banks. Savers make less money on fixed income, and the pigmen make more money because they make a bigger spread on loans and have to pay out less interest to their customers.
Inflation changes the picture
Now that inflation has entered the picture the Fed has a dilemma. Do you keep rates low and risk losing the consumer and the economy due to price inflation? Or do you risk your financial system and housing market by raising interest rates to protect the consumer?
There is a great piece hereon Bloomberg that discusses this.
Here are some comments from the article:
The argument to raise rates:
"Tying Hands
``Inflation is constraining the hand of central banks,'' said Tim Drayson, global economist at ABN Amro Holding NV in London. ``They are starting to realize that they will have to see weaker economies to control inflation.''
Some traders are increasing their bets the Fed will reverse recent cuts later this year. Fed funds futures traded at the Chicago Board of Trade signal a 22 percent probability the Fed will raise its main rate to 2.25 percent by the Sept. 16 policy meeting, compared with 7 percent a week ago.
While U.S. consumer prices rose less than forecast in April, signs that financial markets are improving have prompted policy makers to reappraise the risks facing the economy. Bank of San Francisco President Janet Yellen said May 13 that rate cuts to date ``could lead to higher inflation expectations and an erosion of our credibility.''
The argument to cut rates:
"Nevertheless, a further deterioration in credit markets will deal another blow to the global economy, requiring more policy action. Vincent Reinhart, a former Fed economist and now a scholar at the American Enterprise Institute in Washington, cautions against a ``premature'' end to rate cuts.
Reinhart's Warning
"If credit markets deteriorate again and growth falters, ``central banks will have to roll back talk of future tightening and may even ease,'' he said.
King on May 14 said it's ``quite possible we may get the odd quarter or two of negative growth'' and further ``shocks'' could make matters worse. While Bernanke said this week that tensions in markets have eased, conditions are still ``far from normal.''
Bottom Line:
The Fed has some difficult decisions to make and one wrong move could have catastrophic results. Its no fun walking on a tightrope!
Do we cut or do we raise rates? Tough question isn't it? I wouldn't want to be Ben Bernanke right now.
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