This Rate-Cut Show Drawing Huge Ratings

As the world's markets await the 2:15 p.m. EDT verdict Wednesday, there's far more suspense about this Fed meeting than others in the cycle.
By Robert Mann ,

SAN FRANCISCO -- The moment of truth is at hand. The hour of salvation (damnation?) is nigh. The anticipation is so thick you

can't

cut it, even with a

Ginsu knife.

Of course, I'm talking about the buzz surrounding the forthcoming premiere of

Big Brother 2. No wait. I mean the next episode of

Fear Factor. Or was it

Buffy's switch to

UPN

?

Kidding aside, of course I'm referring to tomorrow's expected rate cut by the

Federal Reserve

, clearly the most hotly debated of the current cycle. There was some controversy over the size of the expected rate cut before the Fed's

May meeting, but nothing compared with this time around.

Even previously sagely market indicators are providing few obvious clues about the outcome of the

Federal Open Market Committee's

meeting tomorrow.

The fed funds futures have long priced in near 100% odds of a 25-basis point ease. But odds of a 50 basis-point ease have fluctuated wildly, from less than 15% on June 11 to as high as 55% early today.

Those odds came tumbling down to under 40% by day's end, following stronger-than-expected reports on consumer confidence and durable goods orders for May. The Treasury bond market sold off dramatically today, partially in reaction to those reports. The price of the benchmark 10-year fell 23/32 to 98 10/32, its yield rising to 5.23%.

Major equity averages reflected the ambiguity surrounding the Fed meeting. The

Dow Jones Industrial Average

fell 0.3% and the

S&P 500

dipped 0.2% today, but the

Nasdaq Composite

rose 0.7% and the

Russell 2000

gained 1.4%.

"I'm a little bearish because there's almost nothing they can do to get things on the right path," said Michael Driscoll, director of listed trading at

Credit Suisse First Boston

(and current member of the "glass is half empty" club). "Until there is some sign companies are making money and not reporting big misses, the market is in for a rough time," regardless of what the Fed does.

The idea that the Fed is somewhat powerless to aid the economy or the market has grown, as 250 basis points of easing so far in 2001 have seemingly done little to help either. A less cynical view is that monetary policy works with at least a six-month lag. Thus, the economy is just now starting to feel the impact of the first rate cut on Jan. 3. Perhaps that's why we're only recently starting to see signs of life in certain economic reports, such as the

Index of Leading Economic Indicators

.

But those hints of a rebound and fears of inflation's revival notwithstanding, there's plenty of evidence that another 50 basis-point ease is necessary. Layoff announcements keep coming and the latest capacity utilization figures showed industrial America at its weakest point since 1983. Additionally, the global economy seems to weaken by the day and the

National Bureau of Economic Research

, the official arbiter of economic cycles, recently indicated a recession may already be under way.

Finally, corporate earnings continue to deteriorate at an alarming rate, with

Merrill Lynch

(MER)

,

Applied Micro Circuits

(AMCC)

and

Xilnx

(XLNX) - Get Report

just the latest, most prominent victims.

Uncertainty about tomorrow's Fed decision is evident in the fact the stock market really doesn't know what it wants this time around.

"The TV talking heads keep telling us we want 50

basis points but I don't know if that's true or not," said Doug Myer, vice president of equity trading at

IJL Financial

in Atlanta. "You've got a marketplace that's searching for something to grab on to. We're floating down river, looking for a rock."

Whether the Fed provides that rock remains to be seen. Whether you really want a rock when you're heading down river is another question.

Remember the Words

A 50 basis-point ease could be greeted either with elation ("Don't fight the Fed") or consternation, because it would indicate the central bank sees no diminution of economic weakness. Similarly, 25 basis points could be viewed as "bad" because, heck, it's only 25 basis points. But it also could be construed as "good" because it would suggest the Fed is less fearful about the economy's future.

"I don't know if the headline number is what we're going to be looking at because everyone is vacillating" about what the market wants, said Jim Bianco, president of

Bianco Research

in Barrington, Ill. "It could get down to one of these deals where it's not what the Fed does, but what it says, and how it's perceived."

A 25 basis-point cut accompanied by a statement indicating the likelihood of another cut before the Fed's next scheduled meeting on Aug. 21 might be the best solution to assuage both the stock and bond markets, he said. Such a move would comfort equity investors that the Fed remains on their side. Simultaneously, it would assuage fixed-income traders' fears that inflation will re-emerge because of the Fed's aggressive rate- cutting. (As an aside, consumer inflation is running at a 3.6% year-over-year rate in the U.S. vs. 3.4% in Europe, Bianco noted. But the Fed says inflation is contained while the

ECB

is wringing its collective hands in worry.)

"You can argue about the effectiveness of easing but one assumption is that all interest rates go down" when the Fed eases, he said. "But long-term rates aren't

this time. A lot of easing is going by the wayside because they haven't done anything for long yields," which ultimately hold the key to the economy. (Martin Mayer made a similar point in an excellent op-ed piece in today's

Wall Street Journal

.)

A quarter-point move with a statement indicating the potential for an intermeeting ease is Bianco's forecast. Of course, he's presuming

Alan Greenspan

& Co. are even a little concerned that long-term interest rates, corporate bond yields, and mortgage rates are all higher since the Fed started easing.

My gut says the Fed will stick to its recent from, and ease by 50 basis points. They may then issue a statement indicating that rate cuts to date are starting to have the desired effect (meaning the end of the easing cycle is near). It's a guess, I admit, but one that's as good as any, given the backdrop.

Speaking of which, a few prognosticators at the fringes have forecast that the Fed moves by 75 basis points. Mercifully, time and space prohibit further discussion of the likely outcome should that occur. But if it does, rest assured tomorrow will certainly be a day to remember on Wall Street.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.

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