A Half Percent Solution?

Will the one half percent drop in the Fed Funds rate be enough to turn the ill tide that was gathering strength in the minds of consumers and business leaders? Probably not, but it was certainly a giant step in the right direction. Ben Bernanke showed that he was his own thinker, and importantly, a forward thinker. While he can say that the decision was data driven, previous Fed chairs have waited longer and required considerably more information before making their decisions. In fact, it was popular to say that the Fed drove by looking in the rearview mirror.

Stock market investors whom had been looking for a move of this size were delighted as the Dow Jones Industrials rose 2.5% and the NASDAQ rose 2.3% on Tuesday. And they have been pretty happy since the cuts as stocks dropped only a little yesterday for the first time in three days when FedEx Corp. cut its profit forecast and the dollar fell to a record low against the Euro.

More than 76 percent, of S&P 500 companies that reported earnings this week beat analysts’ estimates, spurring speculation that third-quarter profits may grow more than the 3.3% forecast in a Bloomberg survey, but almost certainly not fast enough to avoid snapping a streak of 20 quarters of profit growth above 10%. About 65% of the companies in the S&P 500 topped estimates in the second quarter according to Bloomberg.

The cut was sparked by employment unexpectedly falling and retail sales rising less than forecast in August. Whether the rate cut and supportive words from the Fed can reverse developing pessimism remains to be seen. And with record gasoline prices and a falling dollar making imports more expensive the Fed is walking a thin line as they try to stay ahead of inflation.

Foreign currencies are appreciating relative to the dollar as interest rates here decline. It could also mean that confidence in theUSeconomy is diminishing. The U.S. dollar fell 0.8% to $1.4067 per Euro at 4 p.m. inNew Yorkand earlier reached a record low of $1.4098. And Bloomberg reports thatCanada’s dollar traded equal to theU.S.currency for the first time in three decades, due to continued global demand for commodities.

As other countries struggle with inflation fears gold has reached a 27-year high. It is up 12% since dipping in mid-August. Oil climbed to a record for a seventh day, closing at $83.32 a barrel inNew York. But Wednesday’s report of consumer inflation showed no signs for alarm.

Yesterday, the Federal Reserve Bank ofPhiladelphia’s general economic index rose to 10.9 after a reading of zero in August which signaled growth had stalled. The index of leadingU.S.economic indicators fell .6% in August by the most in six months, according to the Conference Board. The measure points to the direction of the economy over the next three to six months. ON the positive side, jobless claims unexpectedly fell last week by 9,000 to 311,000, the Labor Department said. 

Mr. Greenspan is out on the talk-show circuit selling his book so we have heard more than usual from him lately. In the wake of the rate cut he still puts the possibility of recession “somewhat more” than one in three, with home prices likely to drop further and hurt consumer spending. Bernanke agrees that the sell-off in credit markets in August could make the “housing correction more severe and it may have other effects on the economy.”

None of this is to say that recession and or inflation are around the corner. In my view, Mr. Bernanke has acted faster than his predecessor to avert recession with confidence that he has enough leeway to avoid inflation. Time will tell if his bold strategy works. We are firmly in his corner and believe that the economy is fundamentally strong, but pessimism was growing surprisingly fast before the cut. Whether more Fed actions will be required remain to be seen, but we applaud Mr. Bernanke’s efforts so far.