Credit Market Stays in Focus

Headline inflation is still high, and labor costs have been rising. More importantly, aggressive rate cuts could further deteriorate the value of the dollar, which fell modestly vs. the yen and, more significantly, against the euro in response to Friday's Fed action.

Those whose homes were foreclosed on may not see any benefit from a Fed funds rate cut at this point, but they'd certainly suffer from a long period of higher inflation. MKM Partners' chief economist Michael Darda noted that after the Fed funds rate cuts following the 1987 stock market crash, the economy had to cope with four years of uncomfortably high core inflation that included a recession.

Investors will be able to tell if the knot is looser by watching the credit markets that stopped working due to the spillover from subprime mortgages and structured credit. If borrowing gets a little easier for everyone from affluent second-home buyers with good credit to institutions that finance their operations through the commercial paper market, we'll know the markets are on the mend, at least for the time being.

If not, the Fed gave itself the leeway to cut the fed funds rate by acknowledging more risk to the growth side of its current economic forecast. In the statement accompanying its discount rate cut, the Fed said, "downside risks to growth have increased appreciably."