Tuesday, September 4, 2007

Market Volatility and the Fed

Merrill Lynch has cut estimates on several large-cap banks, and says there's a 60% probability of a recession. Now, let's be honest; saying there's a 60% chance of something is only 10% away from having no idea whatsoever. However, one would expect that given recent concerns about liquidity, that such doom-and-gloom would result in a down morning for stocks... and one would be wrong.

At this point (just after noon Eastern), the NASDAQ is up about 1%, and the Dow is up over 30 points. Why?

I think it's because the market is in the process of pricing in a rate cut. A big one, like 50 basis points. The catch is, I don't necessarily see that happening, nor do I think it's a good idea.

First of all, I don't think the subprime problems are a big enough segment of our economy to warrant direct FOMC action. Second, I don't like the idea of the FOMC using policy to reduce market volatility.

When investors get spooked, the market is supposed to go down. When the Fed starts playing with interest rates to shore up stocks, these internal corrections don't happen as often, or as thoroughly, as they should. That can get us into a speculative environment like we had in the late 90s.

Look for no rate cut, or a 25 basis-point cut, in two weeks. Then look for a selloff. That's my prediction.