First Cut the Deepest? Fed Weighs Options

US equity markets sent a bit of a message to Fed Chairman Ben Bernanke and the FOMC board on Tuesday, selling off as a reminder that Wall Street needs another rate cut. Mr. Bernanke has been mum on the topic as the FOMC met today and finishes up their work on Wednesday with a policy announcement due out shortly after 2:00 pm ET.

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The choices are threefold and each bears considerable consequence. The board may lower rates 25 basis points, lower them 50 basis points or leave them as they be.

In September, the board lowered the federal funds rate 50 basis points and the stock exchanges responded with a two-week rally to record highs on the Dow and S&P before lackluster earnings shook the market back to reality. Another 50 basis point reduction does not seem to be necessary, though the Fed may see more weakness, especially in housing and credit markets, as particularly troubling.

The problem with a 50 basis point cut is that it will surely fuel inflation and send oil futures over $100 per barrel. As a committed fighter (thus far in word only) of inflation, it is doubtful that the Fed will make as bold a move.

The 25 basis point reduction is the most likely of outcomes as the cut will satisfy the Wall Street crowd without fanning the inflation flames much.

No rate cut at all would be the most desirable from a monetarist standpoint, as firmness from the Fed might induce a small rally in the US dollar, which has been pummeled recently.

The Fed must weigh their alternatives carefully and proceed in a diligent, professional manner, else they risk destroying the value of the US dollar even more.

On the trading session, declining issues defeated advancers by an 8-5 margin. New highs maintained their lead over new lows, 268-235, a slim margin, indicating an abundance of concern and uncertainty as to the Fed's next move.

Oil actually took a little off the top, losing $3.15 to close at $90.38. Gold and silver also lost ground, with gold off $4.80 and silver down a dime.

The Fed may want to keep some of its ammunition for the future, as dropping the federal funds rate below 4.50% (it's currently at 4.75%) may auger more ill for the consumer, who registered the lowest confidence reading in two years.

Rate cuts can only do so much, and with credit markets still reeling and major banks restructuring following the sub-prime shakeout, Bernanke and his fellows on the FOMC board may consider other measures, or taking a wait-and-see posture, more appropriate.

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