Now that the dust has settled a bit from the Fed’s 50 basis point increases in the Fed funds and discount rates last Tuesday, how did things shake out during the week in the aftermath of the Fed’s surprisingly aggressive action:
• Stock indexes posted a sharp rally, with the S&P 500 making a run at the July highs.
• The U.S. dollar weakened to new lows, with the U.S. Dollar Index barely staying above its all-time 78.19 low.
• Foreign currencies moved up sharply against the U.S. dollar almost all across the board with the Canadian dollar at 30-year highs and even reaching parity with the U.S. dollar.
• Gold prices rose to the highest level in 27 years.
• Crude oil prices hit new record highs.
• Soybean futures reached $10 a bushel and corn prices rallied.
A lot of the higher currency and commodity prices has been attributed to the sinking U.S. dollar and perceptions that it can only get worse. U.S. Treasury Secretary Henry Paulson proclaims that a strong U.S. dollar is in the best interest of the country but adds that “values should be set in a competitive marketplace based on underlying economic fundamentals.”
Doesn’t sound very hopeful for the dollar considering how the effects of the housing slump and credit debacle are weighing on U.S. economic growth. Nearly everyone seems to be painting a scenario of a weaker dollar equaling even higher commodity prices and higher inflation, but the big risk is a potential dollar-selling panic if its value drops much further. Even now there must be big money wondering why they should keep their funds in a dollar that’s losing value. Running the brinksmanship of panic is a little scarey.
One positive: Most people are thinking one way, and you know the market adage about having too many people on one side.
As for the stock market, remember then Fed Chairman Alan Greenspan’s New Year’s surprise in 2001? The Dow had slumped 15% from its peak, people were beginning to worry about a recession, and the Fed had held rates steady at 6.5% when the Fed decided the economy needed a little boost and chopped the Fed funds rate by 50 basis points.
Like last week, that cut was good for an initial shot in the arm for the stock market. Greenspan’s Fed continued to lower rates all the way to 1%, but, ominously, that didn’t keep the R word away. And you probably don’t need a reminder about what happened to the stock market in the two years after Greenspan started his interest rate decline.