Global capital markets, led by credit markets, have been roiled in the last couple of weeks by concerns in the subprime mortgage lending sector.
On Friday morning, in a surprise move, the US Federal Reserve “blinked”, cutting its discount rate from 6.25% to 5.75%.
Prior to this action, it was widely believed that incumbent Fed chairman Ben Bernanke wanted to distance himself from the “Greenspan put.”
So called, because the previous Fed chairman Alan Greenspan was quick to cut both discount rates and the more important Fed funds rate whenever there has been a whiff of deflation in the air.
That belief has been brought into question with this action.
So is this a clever response by Bernanke to target the liquidity in the financial system and not touch the Fed funds rate? Or is it the cautious move of a new kid on the block that will merely forestall the inevitable rate cut?
I think it is the former. I think Bernanke as a matter of principle will seek to establish the credibility of the Fed as an “inflation fighting” one. Even though he may not be a full-fledged hawk in the old Bundesbank sense, all his writings and speeches lead us to believe that he is cut from that same cloth.
I think his hurdle rate to cut the Fed funds rate will be very high (or should I say very low?) growth expectations.
It seems likely that Bernanke will not risk the Fed’s reputation save for the most exceptional of circumstances.
Markets are celebrating too early that the discount rate cut and the accompanying statement imply an imminent rate cut—if not between meetings, at least at the next Fed meeting on 18 September.
Much of this credit crisis is beyond the US banking system. Hedge funds, Wall Street companies and non-US banks have lent money to other hedge funds and proprietary trading books.
Classic Fed intervention, using hazy information about unregulated funds, is likely to be a very blunt instrument.
Notwithstanding all this, economic and earnings fundamentals in India look fine. While we may not have found market bottom yet, long-term investors should stayput.
A whiff of deflation in the air is good for growth markets like India.
So long as it does not turn into a full-fledged global recession (and the evidence of that is scant now), Indian investors may be best served by not blinking!
(Narayan Ramachandran is CEO of Morgan Stanley Investment Management, India. These are his personal views. Send your views and comments at firstname.lastname@example.org)