A huge Federal Reserve induced equity recovery has occurred in the past two days. After yesterday's market equivalent of a tantrum and today's emotional makeup do we have a bottom in stocks and the dollar? The Fed has cut 3.0% in a little more that six months. Regardless of rhetoric 2.25% is likely near the end of the Fed rate reduction cycle for several reasons. The FOMC vote was 8-2, an uncommon number of dissenters, both negative voters wanted a smaller rate cut. Three probable reasons for the negative votes: first, a steady diet of rate reductions has a diminishing positive return for the economy and on market sentiment, time must be given for the stimulus to take effect; second, inflation and the weakening dollar are damaging for the economy, though since last August both have been judged not equal to the risks of the credit crisis; a stabilization or moderate recovery in the dollar would continue to encourage exports and would draw capital and investment into the United States as investors, no longer fearing an ever falling dollar, quickly realize the great bargains currently on hand in the States; third, if the credit crisis erupts again the Fed will surely want to have as much rate ammunition as possible.
A major spur to the equity rally was simple relief, the hope that the credit and liquidity crisis has passed its peak and that the markets can return to less apocalyptical concerns. Traders want to look to he future, the credit and liquidity crisis has prevented that natural market view. Worries about the housing market, except, and a large exception it is, as they provoke more bank and brokerage failures, will have limited effect. Housing prices can and probably will continue to fall but as long as they do not threaten the financial system they will return to the background, as they were for most of the past two years. For the next few months gradually worsening economic data will also have little effect, as the Fed has already supplied the requisite economic medicine and traders know that time is required for it to bring a cure.
Will the markets now (conditionally) freed of the specter of the credit crisis begin to do what markets always do and turn to the future? Will traders attempt to get a jump on the next trend in both equities and currencies? Psychologically, at least the eagerness to move on is palpable. Barring more bank and financial catastrophes have we seen the bottom in both equities and the dollar?