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'Helicopter Ben' Rides Again

Bernanke's rate cut lifts market spirits -- but for how long?

Chop, chop, chop. Is that a helicopter above?

The Federal Open Market Committee called the markets' bluff Tuesday, cutting its fed funds overnight interest rate target by more than traders expected. The 50-basis-point cut shows the Fed has made a nifty about-face after spending a year harping about the risk of inflation.

The promise of more liquidity, and the hope for relief from tight lending standards, ignited a stirring rally in stocks. The

Dow

added 2.5% and the

S&P 500

2.8%. Brokerage stocks soared, led by a 10% gain in

Lehman

(LEH)

and a 7% rise in

Goldman

(GS) - Get Report

. Even hard-hit

Countrywide

(CFC)

joined in the fun, creeping back toward $20 a share after this summer's long drop into the midteens.

Still, it remains to be seen whether Fed chief Ben Bernanke's strong medicine will be effective. If the lower fed funds rate fails to unlock the credit markets, then the boost of confidence will have been futile. Some economists may even resume mocking Bernanke as "Helicopter Ben."

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Indeed, the cut in the fed funds rate will help the debt-laden consumer or overextended homebuyer only if the market-driven, bank-to-bank lending rate called Libor falls in conjunction with the Fed's target, says James Bianco, president of Bianco Research.

Mortgage rates are based on Libor, not the fed funds target rate. The short-term markets that corporations use to obtain capital, the commercial paper markets, need to get cheaper again. Investors in leveraged loans and high-yield bonds need to open their wallets and start buying deals for the cut to be worthwhile, he says.

If the Fed's gamble fails to inspire such confidence, more observers are likely to fall in line behind the many economists who responded to the Fed's cut Tuesday with scorn.

"Helicopter Ben is back in the pilot's seat," said one member of that crowd, Michael Darda, MKM Partners' chief economist and the consummate hawk on rates.

As a Fed governor in 2002, Bernanke famously suggested how the central bank could keep wages and prices from falling into a damaging deflationary spiral. He said the Fed could drop money into the

economy with helicopters, and the nickname Helicopter Ben was born.

Indeed, the Fed's cut has some wondering if Bernanke's just easing the U.S. out of its housing bubble by possibly inflating another one. If the cut doesn't salve the credit markets' wounds, this camp says, the central bankers will be forced to cut again.

"We're creating another bubble," says Bianco, though he admits, "I don't know where it is going to be."

Bernanke had shaken off his dovish reputation since taking over for Alan Greenspan last year, persistently claiming that inflation was the key threat to the economy. To many, this was the right path, because as inflation-sensitive asset classes like gold and commodities rise, the dollar sinks.

These asset classes rose again Tuesday, as gold soared to $724 per ounce, a hair shy of its multidecade high of $725. The dollar fell to resistance points vs. the euro, and oil futures gained 2.25% to close at $82.38 per barrel.

Likewise, risk premiums on inflation-protected Treasury bonds also rose, reflecting some renewed concerns about inflation in the face of more liquidity.

All this said, the Fed didn't abandon its anti-inflation posture. The FOMC's statement accompanying the rate cut takes great pains to emphasize the pre-emptive nature of the decision, which has led many commentators to believe the Fed is hoping this cut will be a one-time event.

"In its actions and its statement, the Federal Open Market Committee indicated a desire to act forcefully now while damping expectations of future monetary policy eases," writes Peter Kretzmer, senior economist at Bank of America. "We foresee a year-end funds rate target of 4.5%."

But Randy Diamond, a trader at Miller Tabak, says he wouldn't want to be across a poker table from Bernanke, given his surprise at the 50-basis-point cut.

"The concerns here are that he's laid all his cards on the table after bluffing only 25 basis points," he writes in an email. "There appears to be no more bullets left in case the rate cuts don't work this time around."

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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