Well, here we are just a few days out from Ben Bernanke’s 1/2 point rate cut…bigger than I - or most investors - imagined it would be. The market got what it wanted, in spades. The market is likely to also end up getting something it didn’t want either….inflation. It was already a worry, but this will only fan the flames. (If you missed my original rant, click here to see my pre-cut blog entry.)
Anyway, a couple things came to mind afterwards.
The first is, where does this leave the Fed to go? Another 1/4 point cut in late October is possible, but were we in such bad shape that the Fed had to take such drastic action in September? We should have never gotten to that point in the first place. All this did was shake things up - and make things trickier.
My second thought…another cut (which by the way the 2/3 of the market is expecting) would be well-embraced by investors now, but what about the longer-term result? I’m talking about the U.S. dollar.
There’s a reason the dollar is at record lows. (See the chart below). It’s not just interest rates, but that’s the biggest reason. More rate cuts are going to drive it even lower. When overseas goods start to cost more on a relative basis, the effect is felt as inflation to American consumers. For the most part, that’s us and the majority of our readers.
BUT………
Here’s where I’m going to depart from the majority opinion though…I’m not nearly as concerned about as inflation as other folks. Why? Ever heard the phrase “Do as I say, not as I do“? Despite the fact that inflation is said to stifle spending, it doesn’t by very much. U.S. consumers have a knack for consuming regardless of the cost (barring some very rare and extreme cases).
More than that, despite what the media commentators would have you think, there’s no statistical correlation between a weak dollar and weak market returns. Nor is there a correlation between high inflation and poor market returns. (I promise - click here to see.)
So what’s my point? Here it is in a nutshell…I’m looking for short-term inflation (few months) to rise while the Fed continues to lower rates. I’m looking for the dollar to get even weaker during the same time. I’m looking for gold (and other commodities) to rise accordingly. (See the other chart below.)
All of those are short-term (multi-month) views though.
In the bigger picture, I expect the dollar to stay weak for years. That’s a good thing though, as it will unwind at least some of our ridiculous trade deficit. I also expect the Fed Funds rate to stabilize around 4.0, and maybe even ratchet up a couple of times after that. I expect inflation to stay persistent - though not rampant - for years…and I think gold will stay firm side-by-side.
And more than anything else, I expect stocks to do well even in the face of all the things that are supposed to be bad for the market. I also expect to see stocks pull back when it seems like they shouldn’t. Sounds contrarian, but I’ve seen it before.
Bottom Line - Don’t get too bogged down by all the buzz surrounding interest rates, inflation, and the dollar. To the average trader it may have some impact with entry and exit timing. To the average investor, it has little impact whatsoever.
By the way, I’m now one of the 2/3 expecting a rate cut in October…a change from my prior stance.
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