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Federal Reserve

is destined to remain behind the curve, literally, as a result of its decision Tuesday to cut the fed funds rate by only 25 basis points. The result will be disappointed financial markets and will cause further accelerated easing in the months ahead.

The decision to cut by only 25 basis points suggests Chairman

Alan Greenspan

is having trouble gathering a consensus in the Fed for a more aggressive response to intensifying global deflation, even as he successfully organizes hedge-fund bailouts.

This is only to be expected, since the establishment will always continue to fight the last war. Witness Europe's continuing obsession with anti-inflationary talk in the lead-up to the euro.

Doubtless the Fed also didn't want to create the impression that it was prone to panic.

But the reality is that even a 50-basis-point cut in the fed funds rate would not have been enough to address deflationary forces, though it would have been interpreted positively by the markets as a sign that the Fed means business.

Investors should now focus on the shape of the U.S. yield curve, which continues to show a restrictive stance given that the fed funds rate is still 20 basis points higher than the long bond even after this week's cut. A 30-year Treasury bond yielding 5.07% and a 10-year Treasury bond yielding 4.55% make it clear that the trend is for much lower interest rates in the months ahead as the U.S. economy slows. In this respect, there are now 525 basis points to zero for the Fed to play with, which is at least 500 basis points more than in Japan.

Paying the Price

The failure to ease more aggressively will, in due course, precipitate renewed downward pressure in world stock markets, global and emerging, given that this week's monetary easing was already discounted. Equities will be further hit by an intensification of the deflationary deleveraging process that will be the consequence of the

Long Term Capital

debacle, an event that also threatens to undermine the credibility of the Fed in terms of its willingness to let market discipline be enforced.

In this respect, pressure will return on


, where the crawling peg exchange-rate mechanism isn't likely to survive many months after President

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Fernando Henrique Cardoso's

anticipated re-election on Oct. 4. The deflationary cost of keeping the system in place is just too brutal. Current Brazilian short-term rates are 49.75%, while


is 3.6% year-to-year.

Cautious on Latin America

Brazilian authorities are banking on a combination of international support and tough fiscal measures postelection to relieve the tension on the real. But the recent rally in Brazil seems to already discount this outcome.

That will imply further pressure on other Latin American markets after the recent relief rally. Investors will also become more cautious in the Latin American region as evidence of the slowdown in the U.S. grows.

Dangers Aplenty in Asia

For its part, Asia should continue to enjoy some relative relief.

Asia outperformed other emerging markets as well as Wall Street in the third quarter. The

MSCI Far East ex-Japan index

fell 8.1% this quarter, compared with a 10.3% fall in the


and a 25.5% fall in the

MSCI Latin American Index


One reason is that short-term interest rates in the region have probably peaked. Another is that there's some evidence of currency stabilization.

Still, this is a


discussion. Dangers remain aplenty.

Hong Kong

will decline much further in due course, with the government's extraordinary intervention in the issue of wage levels at

Hongkong Telecom

the latest example of the SAR government's evident failure to understand the internal logic of the currency board system it purports to uphold. Dedicated investors shouldn't ignore the escalating downward spiral in


, which is beginning to show signs of getting out of control. We may see an un-Japanese-like scramble for collateral as creditors finally panic and longstanding "relationships" are tossed out the window. The


is surely heading much lower into unchartered territory for this marathon bear market.

Plot Lost in Malaysia

A final positive observation: The current public spectacle being played out in

Kuala Lumpur

raises the prospect that the consensus (Greed & Fear included) may have been wrong to conclude as quickly as it did that Prime Minister

Mahathir Mohamad

has won the public relations war in his ousting of former deputy prime minister

Anwar Ibrahim


Greed & Fear has now come to a different view. The situation in Malaysia may turn around quicker than anyone supposes. There may even be a U-turn on exchange controls in the not-too-distant future.

The reason is that it's hard for a government to retain legitimacy in any country when there is a widespread view that the political leadership has lost the proverbial plot. This would now seem to be the case in Malaysia. In purely economic terms, the government has also overestimated the degree to which the offshore ringgit would "return" home following the imposition of controls.

Christopher Wood, the author of Greed and Fear, is the global emerging market strategist for Santander Investment. He is the author of The End of Japan Inc.

(Simon & Schuster, 1994).