Croesus/An investor's view:With confidence in financial markets ebbing away across the globe at an alarming rate the world's most powerful central bank stepped in with an emergency interest rate cut of 0.75 per cent.
This was the first unscheduled rate cut since September 17th, 2001, and its largest single cut since August 1982. Comments from Fed chairman, Ben Bernanke, earlier in January had already clearly signalled that a cut of three quarters of a point was on the cards for end-January. The timing of the cut injected the key element of surprise and was in response to Monday's global equity sell-off which unfortunately occurred on a US public holiday. This meant that before the US open on Tuesday large volumes of sell orders had built up. Therefore, the timing of the Fed's move was aimed at pre-empting panic selling on Wall Street on Tuesday.
In this regard the tactic was effective as European and Asian markets bounced back and Tuesday's falls on Wall Street were limited to about 1 per cent across the main equity indices. However, the cut was not sufficient to negate the overwhelmingly bearish sentiment now pervading global financial markets.
This should not be too surprising given that all that occurred was that an expected cut of 75 basis points was brought forward by one week. Analysts now expect the Fed to announce a further cut of 50 basis points to 3 per cent in the Fed Funds rate when it does meet at its scheduled meeting next week. An eventual move to 2 per cent or even lower during 2008 is now on the cards.
When one considers that there is a lag of at least 6-12 months before changes in monetary policy actually show their effects in the real economy, it is not too surprising to find that equity markets failed to rally convincingly this week. The die is already cast for the US economy for the first half of 2008 and recent economic data suggest that the economy may already be in recession. If this is indeed the case then there is a lot of bad news to emerge in coming months. It will be April before companies start reporting first-quarter financial results which will provide the first hard evidence of what impact the economic slowdown is having on corporate profits.
In addition to monetary easing George Bush has floated proposals for a fiscal boost of up to $150 billion. An expansionary fiscal policy through increased government spending and/or tax reductions does have the capacity to boost a flagging economy. If the policy changes are properly focused then fiscal policy can have a more immediate impact then slow-burning monetary policy changes. For example a tax rebate that puts cash directly into the hands of consumers could be quick and effective in boosting consumer spending.
The difficulty with fiscal policy changes is that they have to be agreed with the US Congress, where it can take many months to pass major pieces of legislation. As the news on the economy worsens, Congress will be under intense pressure to speed up its consideration of any fiscal policy boosting initiatives.
Yet it took until March 2002 for an economic stimulus plan, aimed at recovery from the September 11th, 2001 terrorist attacks, to be signed into law.
Among the current proposals that are likely to be included are individual tax rebates up to $1,600, tax breaks for business to promote investment, an extension of unemployment insurance benefits and more money for the food stamp programme. Even if legislation is passed quickly it will be well into the second half of 2008 before any fiscal boost has an impact on economic activity.
With many equity markets now 20 per cent below their recent peaks, we are now officially in a bear market. With so much uncertainty surrounding the global economic outlook further falls are on the cards. This is clearly bad news for the badly battered Irish market which cannot be expected to swim against the tide. However, there is one small crumb of comfort beginning to emerge which is that the Irish market has begun to do better than overseas markets. In 2007 the Irish market was almost the worst performing equity market anywhere. As can be seen from the table, so far this year the 6.3 per cent decline in the Iseq is much less than the 10.8 per cent decline in the S&P 500 and the 14.5 per cent fall in the FTSE Eurobloc100. This could be the first tentative signal that the Iseq index is close to the eventual bottom of this cycle which would be just the first necessary step in restoring confidence in the market.
