Wednesday, 5 September 2007

Markets rally on Fed cut hopes

US and European stocks did well yesterday. US data were somewhat mixed though.

Manufacturing in the US cooled slightly, the ISM manufacturing index falling to 52.9 in August from 53.8 in July, while auto sales held up better than expected in August.

On the other hand, construction spending fell 0.4 percent in July, worse than economists expected.

But markets are mostly focused on a rate cut by the Fed. From MarketWatch:

Investors will pore over the economic data in the coming week, looking for reasons the Federal Reserve should or shouldn't cut interest rates. But the data will probably be irrelevant to the decision.

It's likely that the Fed will make its move, whatever it is, regardless of how strong hiring was in August, or how exuberant manufacturing purchasing managers were about their order books.

It's likely that the Fed will cut rates on Sept. 18, economists say.

However, Macro Man thinks that "easing rates would be a mistake for the Fed" as he has "yet to see evidence that [credit rationing] is occuring".

He may be right, but I think that there is tremendous pressure on the Fed to cut rates nevertheless simply because there is very little tolerance among politicians and economists for a recession. This may be changing slowly as more and more people realise the excesses such an attitude tends to generate. But a decisive change in mindset is more likely after a market crash or a severe recession, not now.

A central bank that is not willing to raise interest rates when consumer price inflation -- the lower of two measures of inflation -- exceeds 2 percent does not suggest a mindset change. A central bank that raises interest rates when inflation is at zero does.

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