Pushing On A String

We come once again to Federal Reserve time. The futures markets suggest a high probability that the Fed will cut short-term rates by 25 basis points to 4.00% on Tuesday. The bigger question is what sort of statement will accompany the announcement. The Wall Street honchos want reassurance that the Fed will take aggressive action to stabilize their bonus checks, oops, we mean stabilize the economy. We have no doubt the Fed will do what Wall Street wants. Whether they will succeed in stabilizing anything is another question.

The problem is this: whatever generous loan terms the Fed offers to the banks will not necessarily inspire those same banks to be any more flexible in granting credit to businesses and consumers. Economists call this phenomenon "pushing on a string." It is an evocative image; no matter how hard you push on string, all it does is pile up around your feet. Lenders are in no hurry to take on any additional risks after being stung so badly this year. Until that attitude changes, Fed policy will have little lasting impact. Perhaps Ben Bernanke has an unexpected rabbit in his hat, but so far we see no evidence of one. Tighter credit leads ineluctably to economic slowdown.

This outlook is consistent with the recent patterns in sector relative strength. The strongest intermediate-term momentum is found in defensive stocks like utilities, consumer staples and health care. Dollar weakness is allowing materials and energy to also move up, but those sectors face heavy overhead resistance. Our best guess is their momentum will fade shortly.