April 18, 2001

What This Rate Cut Really Means

A 50-basis point interest rate cut by the Fed sparked a rally in the stock market today, but just like the rate cuts in January and February, the good news won't have a lasting effect. Once investors get over the initial surprise of the inter-meeting cut, they'll realize the Fed only made this move out of desperation. It sees that the economy is already in a recession -- probably deeper in a recession than anyone else could guess right now.

According to the Fed's statement, "Capital investment has continued to soften and the persistent erosion in current and expected profitability, in combination with rising uncertainty about the business outlook, seem poised to dampen capital spending going forward. This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, threatens to keep the pace of economic activity unacceptably weak."

In other words, businesses don't have enough cash on hand to keep growing their business, they've already got huge inventories that aren't moving, and a world-wide recession looming on the horizon means things are only going to get worse.

So, the Fed is trying anything it can to get banks to lend more money to businesses who have overspent and who are now facing dwindling or negative profits. But banks aren't going to bite. They're already dealing with rising loan defaults. Banks have had to increase their loan-loss reserves in order to compensate, which reduces their profitability as well.

Once investors realize the Fed's move doesn't change the dismal economic outlook one iota, the stock market's rally will turn into a rout -- and the bear will come back with a vengeance.

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