Sunday, February 10, 2008

Don't let the doomsday headlines and the careening markets scare you

rising home foreclosurers, cranky consumer spending, soaring oil price with inflation implications, nausea-inducing market swings - pileup of indicators --Here we go again. Day after day, Americans are being bombarded by a relentless drumbeat of unsettling economic news. The Dow regularly swings by hundreds of points in a single session as it gyrates near bear-market territory. Oil prices keep bubbling toward $100 a barrel. The dollar is crumbling, and a rogue trader in Paris is blamed for triggering a synchronized selloff heard round the world. We're constantly warned that an ugly recession is looming, if not already here. It's all enough to cause a panic attack. --Don't let the doomsday headlines and the careening markets scare you. Washington is in control --But any slump is likely to be short and mild, mainly because Washington is on the case. Since mid-September, Federal Reserve chairman Ben Bernanke has reduced the target for the Fed funds rate by 2.25 percentage points, with the biggest move, a sudden 75-basis-point cut, coming on Jan. 22. On Jan. 30, the Fed cut another half-point, bringing the target to 3%. It usually takes six to nine months for a Fed rate cut to bolster consumer and business spending. By midyear the flood of liquidity will be channeled into new loans for companies and consumers. A resurgence in easy credit - stoking the appetite for everything from big-screen TVs to capital equipment - will be practically irresistible. Consumer spending will get another boost from the roughly $150 billion economic stimulus plan Congress is poised to approve. Checks that could range from $1,000 to well over $2,000 are likely to start going out to families this summer. The easy money doesn't stop there. The Fed has practically promised even more rate cuts. The markets are predicting that the Fed funds rate will be 2% to 2.5% by year-end. With that kind of aggressive stimulus, look for growth to jump back to the 3% to 3.5% range in the second half of the year. Says Brian Wesbury, chief economist at First Trust Advisors: "You simply don't get recessions when the Fed funds rate is at 3% or below, and the Fed is in a strongly expansionary mode." --It usually takes six to nine months for a Fed rate to bolster consumer and business spending. By mid year, the flood of liquidity will be channeled into new loans for consumers and business. --Consumer spending will get another boost from stimulus package. --Those low rates, though, are creating the conditions for a bigger crisis down the road. "The real challenge will be inflation," warns Darda, "not the near-term economic worries that the financial press is harping on." After fretting over surging prices early last year, the Fed is now ignoring them in its all-out campaign to revive the economy. But the threat isn't going away. In 2007 the consumer price index rose 4.1%, the biggest jump in 17 years. The combination of high oil, food, and metals prices, along with low interest rates and growing global demand, is a classic recipe for inflation. "Much higher inflation is practically inevitable," says Carnegie Mellon economist Allan Meltzer. Eventually the market will wake up to the problem, and so will the Fed. "The real danger is in 2009 and 2010," says Meltzer. "The Fed will be forced to raise rates substantially to kill off inflation, possibly causing a recession." Job market has not falling off the cliff --Jobless claims, a reliable harbinger of recession, have averaged aqbout 325k for the past four weeks, far below the danger point. In hte last two recession, jobless claims increased 25%. Temper your courage --Still, investors need to temper their courage with caution by picking investments that are genuinely cheap.

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