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Stocks may rise on expected interest rate cut

Reuters | September 16, 2007
Herbert Lash

Wall Street expects Federal Reserve policy-makers to cut interest rates next Tuesday to help ease a global credit squeeze, a much anticipated event that spurred stock prices higher this week and could boost them next week.

Investors expect the Federal Open Market Committee to cut the federal funds rate in response to growing concerns that the U.S. economy is slowing and may be heading into recession.

Short-term interest rate futures on Friday indicated investors believe a half a percentage point cut in the federal funds rate is slightly more likely than a quarter percentage point cut when the FOMC meets.

Some investors say the stock market has priced in a quarter-percentage point rise, limiting any upside. But if the past is a guide, investors will react to the actual event, said David Bianco, chief U.S. equity strategist at UBS in New York.

"I think the market's going to have a positive reaction to it, I really do," said Bianco, who expects a 25 basis point cut in the federal funds rate and a 50 basis point cut in the discount rate.

"It will signal a response to what's going on, to try to prevent credit market troubles from spreading to the real economy," he said.

Reuters polls showed on Thursday that economists see about a 30 percent chance that the United States enters recession in the next 12 months should the effects of a housing slowdown continue to seep into the wider economy.

Major U.S. stock market gauges moved up this week in anticipation of a rate cut, with the Dow Jones industrial average (.DJI: Quote, Profile, Research) posting its best week since April.

For the week, the Dow rose 2.5 percent, the benchmark Standard & Poor's 500 Index (.SPX: Quote, Profile, Research) gained 2.1 percent and the Nasdaq Composite Index (.IXIC: Quote, Profile, Research) rose 1.4 percent.

On Friday, the Dow closed up 17.64 points, or 0.13 percent, at 13,442.52; the S&P 500 closed up 0.30 points, or 0.02 percent, at 1,484.25, and the Nasdaq closed up 1.12 points, or 0.04 percent, at 2,602.18.

OPTIONS EXPIRATION TO STIR VOLATILITY

Investors will want to see if the subprime mortgage trauma has worsened for four big investment banks -- Lehman Brothers (LEH.N: Quote, Profile, Research), Morgan Stanley (MS.N: Quote, Profile, Research), Bear Stearns Cos. Inc. (BSC.N: Quote, Profile, Research) and Goldman Sachs Group Inc. (GS.N: Quote, Profile, Research) -- when they release fiscal third-quarter earnings results over three days next week.

The release of third-quarter earnings for most companies doesn't begin in earnest until October.

The banks have diversified business models and are able to profit from worldwide economic growth, which will alleviate any downdraft of credit market issues, said Michael Cuggino, chief investment officer of the Permanent Portfolio family of funds in San Francisco.

"We may be surprised to find the negative impact was not as great in the third quarter as people may have expected," Cuggino said.

Volatility is likely to intensify at week's end because of the expiration of four different options and futures contracts, a quarterly event known as "quadruple witching."

Investors also will be parsing inflation data for August, information on housing starts and building permits, also for August, and unemployment claims for the week ending September 15.

According to a Reuters poll of economists, producer prices, which are a measure of prices paid at the farm and factory gate, are expected to decline 0.2 percent in August when the Labor Department releases data on Tuesday.

The following day, a Labor Department reading for the Consumer Price Index, a key inflation gauge, is expected to be unchanged from July.

Also on Wednesday, housing starts for August are expected to decline to 1.35 million and building permits are expected to decline to the same amount, 1.35 million.

On Thursday, a Labor Department report on U.S. workers signing up for jobless benefits is expected to show initial claims of 321,000.

Although the labor market has shown recent softness and the housing sector is clearly suffering, both Bianco and Cuggino said the overall U.S. economy is not in that bad shape.

"It's been almost astounding how good things have been outside of the financial economy," Bianco said. "For the most part the energy companies, the industrial companies and the technology companies are on the verge of a full recovery of the dip."

Cuggino said that "for every financial service firm that's having difficulties, there's a technology firm that's experiencing pretty good earnings growth and pick-up in business."

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