The reason we are getting these CRAZY swings in the stock market is because traders are confused about the direction of the economy. Specifically, they are uncertain about the impact of the credit crunch on consumers and corporations. That's why the perception that the Fed is being vigilant to watch for significant signs of deterioration in the economy is so important,and why things like letters from Bernanke to Schumer and his speech tomorrow on housing and the economy are critical.
Here are the major questions bandied around on the Street:
Tighter credit: will consumer and businesses be able to stomach tougher underwriting standards, even if rates remain where they are now?
Consumers: how much will they slow down spending?
China: with such dependency on the U.S. consumer to fuel its growth, what will happen to the economy if GDP growth estimates were reduced from, say, 10% to below 7%? Would that be tolerable, or would it lead to social unrest?
Corporations: will there be a change in capital spending?
M & A deals: who's taking the haircut, and how do you share it? And how do you do new deals?
Those arguing against a rate cut have been saying that the Fed should not be bailing out risk takers. There is no disagreement on this: the Fed SHOULD NOT be bailing out risk takers. But there are larger issues at stake here. If the whole economy tanks because of a seize up in liquidity that creates a cascading series of effects on housing, the consumer, and corporate profits, then that IS very much an issue for the Fed.
The Fed has a tough challenge--they don't want to be viewed as bailing out hedge funds, but they do need to stabilize the markets. Stock traders, for the most part, believe that Bernanke will find a way to accomplish both objectives.
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