Expectation is supposed to be what it is all about. If a company announces a rise in profits, shares don’t necessarily rise. It depends on whether the profit increase was expected. If an economic report reveals a slowdown in growth, well, if the announced slowdown was not as bad as expected, then the markets can go out and buy. But yesterday, it wasn’t like that. Yesterday, the markets had all expected a cut in the US rate of interest, but many had hoped for a half a per cent cut. Instead the Fed did less than the markets had hoped for. In fact a ΒΌ per cent cut was announced, but one member of the Fed’s rate-setting committee voted to keep rates on hold. In the accompanying statement, the Fed went on about inflation dangers, and then many commentators said they were now less sure of future cuts in rates. And yet, markets went out and bought, with the Dow rising 137 points. It appears that once again the markets have said, “The news is good; now, what is the news?”
So, the US rate of interest is back down to 4.5 per cent. You may recall, the Fed upped rates from 1 per cent to 5.25 per cent over two years from June 2004 to June 2006 and then it kept rates there until September, when all the brave talk of rewarding banks for excessive risk-taking went up in flames, with a panic half a per cent cut in interest rates.
For most of 2006, the US rate of interest was actually higher than in the UK, a differential that led many to predict a fall in sterling. But instead, it went the other way round, with the dollar actually falling against the pound last year. But since the Fed began its phase of slashing interest rates the dollar has fallen further still.
On September 18, when the Fed’s half a per cent cut was announced, there were 1.9903 dollars to the pound and 1.368 dollars to the euro. As of this morning the dollar to pound ratio had gone within a whisker of $2.08, and there were just shy of $1.44 to the euro.
In part, it’s the rising dollar that is behind rising oil. Up again yesterday, this time it passed $96, but it’s not the only reason. Yesterday’s latest high in the price of oil was partially down to the revelation that oil inventory levels in the US were lower than expected, suggesting, by the way, that the high price of oil is not just down to terrorism fears, but that there are solid economic fundamentals behind the spike too.
The rising price of oil illustrates perfectly the dilemma facing Uncle Sam. As the dollar falls in the US, so too do import prices. This could lead to higher inflation, cancelling out the benefits of the dollar’s falls.
There is still a feeling out there that the Fed will lower rates again, but not until next year, but never lose sight of the fact that the fundamental problem with the US is that savings are too low, and borrowing too high. It’s been like that for years of course, but right now it seems the US is beginning to pay the cost of this.
And by celebrating the Fed’s more-pessimistic stance, the markets were doing little more than burying their head in the sand.
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