Saturday, August 18, 2007
The Fed acts, or did it react?
Headliner of the week is the decision by the Fed to cut back on the discount rate by 50 basis points from 6.25 to 5.75. The discount rate is the rate the Fed charges banks to borrow funds from it.
In doing so, the Fed said it was "monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets." It also added that "financial market conditions have deteriorated and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward."
Just earlier this month, they had emphasized that fighting inflation was more of a primary concern than focusing on economic weakness which had been accelerated by the sub prime fall out. We should question the sound judgement displayed by this team of highly revered economic pundits. It comes as no surprise anyway since previous boards have also shown the tendency to lag between monetary policy decisions and the changing economic dynamics.
This move will not impact consumer interest rates, a reduction in the more important federal funds rate will do that trick and it is now widely expected that the Fed will trim that rate by at least 25 basis points from 5.25 to 5 percent when they meet on September 18th. Friday’s decision however did give a lifeline to many businesses facing credit and liquidity crunches, chiefly mortgage companies which have been hamstringed by severe lack of short term financing needs.
The markets, as expected, ingited on the good news sending the Dow back up to close at above 13,000 but still more than 1,000 points off its July 20 closing high of 14,121. The S&P 500 index rose 2.5%, the most in 4 years to 1,445.94. Bond markets were calm, the benchmark 10-year note closed at a yield of 4.68 percent.
I am of the conviction that the Feds belated move will calm the storm and investors will go back to focusing on fundamentals and buying earnings. I have since bought back into the market through my 401K and allocated as follows.
• 28% Tagret 2040
• 30% international
• 10% S&P 500
• 20% Fixed income
• 2% Small Cap
• 10% Value
Year to date return is a measly 6% but could have been worse if I hadn’t fled to the safety of bonds when the market begun its downward spiral!