With the latest economic data being mixed, coupled with a falling dollar and new housing sales dropping to the lowest they have been in seven years the fundamental aspects of the economy are somewhat unsettling. While not everything is bad in the economy - jobless claims fell by 15,000 bringing the total number of jobless claims in 298,000 in the month of September and official inflation statistics show a low reading - Wall Street has overlooked most of the negative data and been extremely optimistic since the Federal Reserve decided a rate cut was necessary to ease the nation’s credit problems. With this myopic focus on the Federal Reserve’s willingness to cut rates in order spur the economy, I do not see the stock market making any major declines in the coming months even if further deteriorating in the economy hits, as poor data will likely draw another rate cut-relief rally.

If the Federal Reserve continues to cut rates, what will be the probable impact of that course of action? The strength of a country’s currency is heavily impacted by interest rate policies. When interest rates are lowered in an attempt to relieve pressure and spur the economy, the currency typically weakens relative to others as investors will transfer funds out of countries with low interest rates and deposit the funds in countries with higher interest rates in order to receive a better return on fixed-income investments. While the classic economics model says that lower rates translate to stronger growth and higher rates slow inflation, the high interdependence of economies today should call that logic into question. As a country’s currency falls the people in that nation lose buying power because foreign goods effectively cost more. This is one of the main causes of inflation. The Federal Reserve can raise interest rates to strengthen the dollar and slow inflation, but with the Federal Reserve’s current policy to lower rates we are stuck between a rock and a hard place between keeping funding available and trying to prevent inflation.

On the other hand, it may not be such a hard place for the Federal Reserve to be in if they are willing to debase the dollar in an attempt to prop up the market until the 2008 elections. Between that and the Beijing Olympics, both United States and Chinese government officials have massive vested interests in keeping their respective economic wheels greased, and part of this might involve propping up the other country’s economy as long as they can. In order to prove that China is truly a major economic power the Chinese government needs their economy to be in the midst of economic boom during the coming Olympic Games. This, coupled with the political importance of having the US economy continuing an upward swing going into the Presidential Election, leaves little chance of the Federal Reserve and the Chinese officials letting a major market downturn take place in the coming months.

Overall, I believe the information that comes out daily with regards to the market makes it is easy to see fundamental reasons why the markets should experience a correction in the coming months. Unfortunately, I believe that the overwhelming sentiment right now is that as long as the Federal Reserve keeps interest rates low then equities are still cheap and are better investments when compared to fixed income investments. Until the end of 2008, I feel that the Federal Reserve will be forced into further devaluing the dollar by keeping interest rates low in order to give the people what they want - cheap debt - and that bodes poorly for whoever is left holding cleanup responsibilities in 2009 and beyond.

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