great analysis by terry mccrann

The great rate wait
Comment by Terry McCrann
02-07-2006
From: The Sunday Telegraph
THE official interest rate was raised for the 17th successive time in the US last week. Our Reserve Bank board meets on Tuesday. It will NOT lift our rate.

The rate rise was seen as great news for shares in the US. Wall St surged on Thursday, after the rise, although it then gave back about a quarter of the gains overnight Friday.
The combination was seen as great news for us Down Under. On Friday, our market shot straight through the 5000 mark, rising more than 1.5 per cent and adding about $15billion to share values.

With seemingly only one major exception. Telstra. Its shares lost a penny as investors continued to digest CEO Sol Trujillo's Wednesday speech and semi-apology.

In my view the Wall St enthusiasm was seriously misplaced. And was based on a serious misunderstanding of the dynamics of interest rates in the US.

That's to say, it was all about "the pause". Would the Fed now take a break from raising the rate by a quarter-per cent at its meetings that take place every six weeks?

The general consensus was that it would. So, happy days are here again.

Wrong, and wrong again.

First, there was no problem with the rate hike itself. True, new Fed head Ben Bernanke had talked himself so far into a corner, that he HAD to hike. And hike by a quarter.

The speculation late in the piece that he might go a half was absurd - demonstrating only that the "speculators" didn't have the faintest idea what they were talking about.

The problem was in the statement itself. Far from signalling that the Fed would now pause, it in fact signalled the exact opposite. That it might pause but that also it might not.

The important thing to take away from that was not the "bet each way" but that the Fed DOESN'T KNOW!

It doesn't know for two broad reasons. That there are factors suggesting inflation is still a potential problem - so it might have to keep hiking. And there are factors which suggest the US economy is already cooling - so it would pause and even consider cutting.

And secondly, it doesn't know which will evolve into its "knowledge" by the time of the next meeting mid-August. Now, as far as investors rather than homeowners and buyers are concerned, the key thing is that a pause in US rate hikes is actually NOT good news. And that's investors HERE just as much as on the Street.

It doesn't have to be actual BAD news. As in something akin to another October 1987. But a real - as in, extended, pause - would mean the US economy was slowing. That would be negative for corporate profits and so negative for share prices there and here.

And if it turns out that there's no pause, it would mean inflation was still a problem. And the combination of higher inflation and further rate increases in the US would be negative for share prices there and here.

The real problem is a combination of something deeper. Ben Bernanke's mishandling of the words around what he might do with US interest rates since he got the job after the legendary Alan Greenspan at the start of the year.

And the fact that it was always going to be difficult as the US - and the world - finally got weaned off the super-low US rates.

Bottom line then. Don't be fooled by big jumps in the US market. Wall St is going sideways (at best) into 2007. Where our market goes will be determined by the combination of that and what happens to commodity prices courtesy of China.