Personal Finance Advice

For the second time in two weeks the stock market rallied for it largest gain in five years.  The Dow Jones surged 420 point for it’s fourth largest gain ever as blue chip financials lead the charge.

The Fed cut the benchmark fed funds rate by 75 basis points to 2.25%, it’s lowest level since December of 2004.  Over the weekend the Fed announced an emergency rate cut of 25 basis points to 3.25% in it’s lending rate to financial institutions.  It also opened up a new lending facility for securities firms and increased the term of it’s loans from 30 days to 90 days.

While it was less than what the market had been expecting it couldn’t put a damper on the relief much of Wall Street felt after Goldman Sachs and Lehman Brothers both released quarterly earnings statements that beat analyst’s estimates.  Both companies rebounded sharply on Tuesday after taking big hits to their stock values when investors began a general selloff of financial stocks after the fire sale of Bear Sterns  to JPMorgan was announced on Monday.  There was a growing fear for many investors of an imminent collapse of the other investment banks.

The companies reassured investors of their strong capital positions and that they would not meet the same fate as their rival Bear Stearns when it ran out of cash and was unable to meet it’s margin calls.  The estimated cash and short term assets for Goldman and Lehman were at $60 billion and $90 billion respectively.

While a strong rally when a rate cut is announced is nothing new, it will be interesting to see if the market will be able to maintain it’s momentum.  The effect of the rate cut on exchange rates and commodity prices may start to erode those gains in the upcoming days.

Economists were surprise on Friday when the Labor Department released inflation figures for the month of February.  The Consumer Price Index remained unchanged for the month after it was expected to rise by 0.3 percent.

The report could open the door for a full percentage point rate cut when the Fed is scheduled to meet on Tuesday.  Futures traders had been betting on a 75 basis points cut but many were increasing their bets for a full point cut after the report was released.

However, inflation is still a concern, with oil trading above $110 a barrel and gold breaking the $1,000 an ounce mark for the first time ever.  The fact remains though that with core prices remaining virtually unchanged, it does allow the Fed to act more aggressively in it’s policy initiatives in the near future.

The situation in the credit markets may force the Fed to do just that.  On Friday, the Fed along with JPMorgan moved to provide emergency funding for Bear Stearns Co., preventing the imminent collapse of the nation’s second largest underwriter for mortgage backed securities. 

It was a break in tradition for the Fed, which normally doesn’t interact with non-traditional banks in this manner.  However, desperate times call for desperate measures and the collapse of the investment bank would have sent shock waves through the entire financial sector.  With many firms struggling in a ever worsening credit crisis, the Fed may have to act again in the future to prevent the failures of other financial institutions.

There is a fear that this is a bad precedent being set, that firms can invest irresponsibly, only to hold out their hands to the Fed in their times of need.  Nonetheless the Fed had to act in this case because the alternative would have been unthinkable.

As it looks more and more likely that the economy will enter a recession in the upcoming months, many Americans are wondering how bad it will get.  The root of our current economic troubles, the housing market, continues to grow worse.  Housing prices fell again last month as an increase in foreclosures adds to the glut in supply in the market.

The economy lost jobs for the second month in a row as stocks fell to their lowest level in nearly two years.  The Labor Department reported that 63,000 jobs were lost for the month of February following the 22,000 in losses for January.

The Dow fell under for 12,000 for the first time since August of 2006 as bad economic data and high oil prices sent stocks tumbling.  Earlier in the week oil rose to over $105 as OPEC announced it was maintaining it’s production at their current levels.

Energy prices are expected to continue rising, but how high can the price of oil go? Some analysts are saying $120 but there are others who say it could top $150 by the end of the year.  European Central Banks announced this week that they were not cutting interest rates and futures traders are now betting that the Fed will cut rates by 75 basis points later this month.  This will put enormous downward pressure on the dollar in exchange markets and force the price of dollar denominated assets like oil upwards.

The high price of oil is starting to take it’s toll on consumer spending as well.  It is estimated that every $1 increase in the price of oil costs Americans an extra $100 Billion a year.

Amidst all the gloomy economic news is the specter of inflation.  The Fed has had no choice but to put it in the back burner as it slashes rates in an effort to keep the economy from stalling.  As the credit crunch worsens it has had to pump more and more cash into the money supply to compensate.  This week it announced it was making in as much as $200 billion more available to banks as it increased it’s Term Auction Facility amounts from $30 billion to $50 billion.

There is a real threat that we could be entering into an era of stagflation that could last for quite a bit.  I would say that until the housing market starts to improve, we really have no idea how long this economic downturn could last.