Rate cuts are on the way, but it’s not a good sign: Kohler

Wall Street rallied overnight, albeit unconvincingly, because there is now a greater prospect of rate cuts around the world. In fact, make that a certainty.

Equity markets really do prefer to look on the bright side of life where possible.

Wall Street rallied overnight, albeit unconvincingly, because there is now a greater prospect of rate cuts around the world. In fact, make that a certainty.

OK, the rate cuts are coming because the news is bad, so bad that commodity prices are tumbling in anticipation of a global recession, or something approaching one, but – hey, a rate cut is a rate cut.

The oil price is now down to $US95 a barrel, having zoomed past the $US100 that OPEC was apparently trying to defend (and by the way the Tapis price in Singapore has gone from a 10% premium to West Texas Intermediate to a discount of 2%).

And on the London Metals Exchange last night zinc and nickel fell more than 6% each and the LME index was down 3.5%.

The broad CRB commodity price index has now fallen 25% since 2 July, the bailout of the Fannie Mae and Freddie Mac and the collapse of Lehman Brothers has snuffed a budding late-August rally, so the CRB has dropped 10% since the start of September.

And last night the US Labor Department reported that the consumer price index fell in August for the first time in nearly two years, and the year-on-year inflation rate has fallen from 5.6% to 5.4%.

In other words, inflation is yesterday’s problem. The attention of all central banks, including the lemon-sucking chairman of the European Central Bank, Jean-Claude Trichet, will soon turn urgently to bolstering demand, not dampening it.

Whether or not the Lehman collapse produces a wider meltdown and recession – and the US authorities are betting that it won’t because they let it go – and whether or not there are more collapses such as AIG, we are entering a period of below capacity economic growth around the world.

Stagflation is very unlikely to be a problem unless OPEC takes drastic action to restrain supply and there is absolutely no slowdown in Chinese demand. Both of these things would be needed, and neither seems likely.

Indeed stagflation – an international bogeyman only a month or two ago – appears to be off the agenda already.

The only factor acting against further rate cuts in the United States is the extent of monetary policy easing already – the Fed funds rate was cut from 4.75% to 2% in the eight months between last September and April this year.

But in fact all central banks currently have their official cash rates above the lows of the previous cycle. For the US the previous low was 1% – half the current rate; in Europe the current rate is 4.25% compared to a previous cycle low of 2%; and cash in the UK is now 5% versus a previous low of 3%.

So on that basis there is both the room and the need for rate cuts everywhere. Indeed Australia and New Zealand have already begun.

When stocks rally because rate cuts are coming, it’s often a death rattle; it doesn’t take too long for the reason for the rate cut to dawn on the market.

This article first appeared on Business Spectator