Friday, September 14, 2007

Some Thoughts on the Fed

Next week, the Fed will make its decision on what to do with interest rates. This is the major driving force in the markets right now. The market has virtually already priced in a rate cut, and it would be a shock if no change is made. But I'd like to look at the debate on how much to cut, and what it means. The question is whether to cut a quarter point or a half. The market typically reacts positively any time rates are cut because anytime access to money is cheaper, it helps the economy. But if the Fed cuts a half point, this is basically saying that the economy is worse than most people think, and might make investors worried. If the Fed cuts a quarter point, some investors may think that we were expecting that, and it isn't enough.

Personally, I think the best move is to cut a quarter point, and the rest is up to Bernanke and the message that he delivers. Its up to him to remind investors that the Fed will step in in the future if needed, but isn't here to bail out lenders that made poor loans, or investors that made poor speculative decisions.

The market has been performing decently in the past few days, but Bernanke shouldn't use it as a reason to leave rates unchanged. The market prices in future events, and it is acting pretty well in anticipation of the rate cut. So Bernanke needs to walk a fine line next week.

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