Geoff Cutmore - Morning Thoughts

Bailing Out or Weeding Out?

Fed Chief Bernanke embraced the moral hazard and decided to act. The Fed blinked, cut the discount rate, and markets in Europe exploded out of the gates this Monday morning. Alan Greenspan has in the past demonstrated that a sell-off in markets could be halted by cutting interest rates – but is a Bernanke Fed prepared to repeat the trick?

We had a useful conversation with David Tavadian at Commerzbank this morning, who suggested inflation expectations appear to be shifting...and in favor of a cut in U.S. base rates.

The market now must wait until Sept. 18 to see whether the Fed is prepared to slash the Fed funds rate (unless we get an emergency move) – and judging by the moves in interest rate futures, the market is firmly wedded to the idea that there will be a cut. Should Bernanke deliver on the expectations?

To judge by a good deal of market commentary, he shouldn’t. The hair shirt school of thought argues there should be a period of pain, whereby somehow the reckless lending officers of major financial institutions should suffer for their indiscriminate behavior. CEOs of banks and other institutions that have benefited from the massive expansion in credit should suffer with their jobs where the organization has been reckless. This may appeal to some deep-seated sense of moral outrage about the unequal distribution of wealth, but it doesn’t propel the discussion along very far.

As Tavadian pointed out, the Fed must be focused on growth foremost – and if growth is put at risk by this current challenge to the economy then it must act. Bernanke cannot, and I think will not, be prepared to see the U.S. economy slide towards recession. So the key to the next move on rates is likely to be in the data. The fed will be less concerned about punishing reckless lenders than preventing the excruciating hardship that comes with a more generalized slowdown.

Nick Hodson was our guest host from Lloyds TSB Private Banking and he said he was looking for entry points. He believes the valuation story is starting to look interesting. He suggested a large cap focus, and picked out HSBC, Nestle and Tesco as companies he is doing further work on.

Feedback welcome - here.