Bernanke Weighs Recession Risk Against Investor Cave-In Charge

Yuriy

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Bernanke Weighs Recession Risk Against Investor Cave-In Charge


By Steve Matthews

Sept. 18 (Bloomberg) -- The Federal Reserve will probably cut its benchmark interest rate today for the first time in four years, seeking insurance against a recession. The main question is how big a policy Chairman Ben S. Bernanke is ready to buy.

While a quarter-point reduction in the federal funds rate may not be enough to bolster growth and investor confidence, a half-point cut might fan inflation and be perceived as giving in to pressure from Wall Street firms that made bad bets, especially in the market for securities backed by subprime mortgages.

Bernanke and fellow policy makers ``are really caught,'' said Robert Eisenbeis, a former research director at the Fed's bank in Atlanta who attended meetings of the rate-setting Federal Open Market Committee before retiring early this year. ``The Fed needs to avoid the perception of bailing out the markets, lenders or borrowers.''

The FOMC will opt today for a quarter-point cut to 5 percent in the rate that banks charge each other for overnight loans, according to the median prediction of 134 economists surveyed by Bloomberg News. Twenty-three of the forecasters projected a half-point move, which traders think is coming sooner or later: Interest-rate futures indicate a rate of 4.5 percent by year-end. The decision is scheduled for about 2:15 p.m. in Washington.

Most-Analyzed Statement

Whatever today's decision, the statement accompanying it may be the most-analyzed in years. Reports portray a weakening economy: The Labor Department said Sept. 7 that that the U.S. last month suffered its first job losses since 2003. Investors will look for hints of further cuts -- such as a pledge to act as needed to safeguard the six-year expansion -- or language that plays down the risk of higher inflation.

``The markets will be disappointed by 25 basis points,'' said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. ``If they do more now, they may be more cautiously optimistic in the statement. If they do 25 basis points, they will commit to doing more. You can argue it either way for which is the more powerful.''

The Fed's decision today will come hours after the government report on August wholesale prices; the Consumer Price Index is released tomorrow. As recently as the last FOMC meeting Aug. 7, officials said inflation was the ``predominant'' risk to the U.S. economy.

Just 10 days later, the Fed acknowledged that ``downside risks to growth have increased appreciably'' and pledged to ``act as needed.'' Policy makers will probably use similar language today, economists said.

`A Considerable Amount'

``The statement will point to the growth rate as the predominant policy influence and give the market the flexibility to price in a considerable amount of easing,'' said Brian Sack, vice president at Macroeconomic Advisers LLC in Washington and a former Fed economist.

Bernanke, 53, and his team may take additional steps to increase liquidity, including lowering the discount rate --which the fed charges on loans it makes to banks -- or altering terms for collateral used for loans from the central bank, economists said.

In their public comments, Fed officials have diverged in their assessments of risks to growth, making today's meeting particularly tough for analysts to handicap.

Since the August jobs report, Fed Governor Frederic Mishkin and San Francisco Fed President Janet Yellen have highlighted threats to consumer spending. By contrast, Fed bank Presidents Richard Fisher in Dallas and Charles Plosser in Philadelphia noted signs of resilience in the economy.

No Cave-In

At the same time, all agree the Fed doesn't want to be seen as caving in to funds that piled into the market for securities linked to subprime mortgages, those made to borrowers with poor or limited credit histories.

As defaults on such loans climbed, investors fled, making it tough for some companies to obtain credit; the market for asset-backed commercial paper shrank the most in at least seven years.
``It is not the responsibility of the Federal Reserve --nor would it be appropriate -- to protect lenders and investors from the consequences of their financial decisions,'' Bernanke said in an Aug. 31 speech in Jackson Hole, Wyoming.

Anything seen as a bailout might increase ``moral hazard'' -- spurring investors to take on even more risk, comfortable in the belief the Fed will make good their losses.

Rivlin Regrets

Former officials including Alice Rivlin, who was a Fed vice chairman under Bernanke's predecessor Alan Greenspan, have expressed regret over cutting rates three times in 1998. The economy continued to expand with little harm from turmoil in financial markets at the time, data later showed.

``The moral hazard argument is a powerful one,'' said Philip Orlando, who helps manage $260 billion as chief equity market strategist at Federated Investors Inc. in New York. As a result, he predicted, ``the market is wont to be disappointed'' by today's decision.

Others say policy makers will focus more on the recent economic data showing signs of a sputtering economy. Besides the decline in August payrolls, retail sales and industrial production rose less than forecast last month, and the Commerce Department may say tomorrow that builders broke ground on the fewest new homes since 1995.

Bernanke and fellow policy makers ``are trying to step away from the Greenspan model,'' said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago. ``But at the end of the day, they will act the same.''

To contact the reporter on this story: Steve Matthews at slanman@bloomberg.net .

http://www.bloomberg.com/apps/news?pid=20601009&sid=avkq8LxPdSmU&refer=bond
 

Yuriy

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U.S. Stocks Advance on Lehman Profit, Interest Rate Speculation


By Lynn Thomasson

Sept. 18 (Bloomberg) -- U.S. stocks advanced after profit at Lehman Brothers Holdings Inc. exceeded analysts' estimates and investors speculated the Federal Reserve will cut interest rates when it meets today.

Lehman, the biggest underwriter of U.S. mortgage bonds, gained after fees from stock trading offset some losses from subprime mortgages. Best Buy Co., the largest U.S. electronics retailer, climbed the most in a year on a forecast for higher earnings. Procter & Gamble Co. rose after the biggest consumer- products company affirmed its profit outlook.

The Standard & Poor's 500 Index rose 10.73, or 0.7 percent, to 1,487.38 as of 11:45 a.m. in New York. The Dow Jones Industrial Average added 87.47, or 0.7 percent, to 13,490.89. The Nasdaq Composite Index jumped 13.62, or 0.5 percent, to 2,595.28. European shares rallied on Lehman's report, with the Dow Jones Stoxx 600 Index rising 5.4, or 1.5 percent, to 367.58.
Lehman's profit and a report that showed prices paid to U.S. producers had the steepest drop since October may allay investor concern the economy is headed for a recession. Economists expect slowing inflation to give the Fed room to reduce its benchmark interest rate for the first time in four years.

``That will give the economy a little bit of an insurance policy,'' said Adam Friedman, who helps oversee $2.7 billion at Integrity Asset Management LLC in Cleveland. ``Inflation is low, the consumer is OK, the credit markets will hopefully stabilize and we'll get back to a more normal position.''

Quarter-Point Cut

The Fed decision on interest rates is scheduled for 2:15 p.m. in Washington. Economists surveyed by Bloomberg expect a 0.25 percentage point reduction to federal funds, on average.
Lehman increased $2.43 to $61.05. Third-quarter net income fell 3 percent to $887 million, or $1.54 a share, as revenue from fixed-income trading dropped 47 percent. Earnings topped the $1.48 a share average estimate of analysts surveyed by Bloomberg.

Lehman is the first of the five biggest U.S. securities firms to post third-quarter profits. Morgan Stanley reports results tomorrow, followed by Goldman Sachs Group Inc. and Bear Stearns Cos. on Sept. 20. Merrill Lynch & Co.'s earnings will be published next month.

Best Buy added $1.94 to $46.48. The retailer said back-to- school shopping increased sales of laptop computers. The company expects to earn $3 to $3.15 a share for the year, up from a range of $2.95 to $3.15. Analysts estimate $3.02.

Procter & Gamble climbed for a seventh day, adding 54 cents to $68.49. Earnings per share this quarter will be about 88 cents to 90 cents, the company said.

Producer Prices

Producer prices fell 1.4 percent, the Labor Department said in Washington. The decline was more than the 0.3 percent drop forecast in a poll of economists by Bloomberg and followed a 0.6 percent increase in July. So-called core producer prices, which exclude fuel and food costs, rose 0.2 percent, after a 0.1 percent gain the month before.

Adobe Systems Inc., the biggest maker of graphic-design software, climbed 27 cents to $43.33. The company said yesterday that third-quarter profit more than doubled to $205.2 million. Sales gained 41 percent to $851.7 million in the period ended Aug. 31, beating the average estimate from analysts of $789.8 million.

Kroger Co. rose $1.86, or 6.9 percent, to $28.88 for the steepest gain in the S&P 500. The biggest U.S. supermarket chain exceeded analysts' profit estimates and raised its annual earnings forecast as lower prices and more promotions helped spur sales.

Foreclosures Double

The number of Americans who may lose their homes to foreclosure more than doubled last month from a year earlier, according to a report by RealtyTrac Inc., as the riskiest borrowers with adjustable-rate mortgages saw their monthly payments rise.

E*Trade Financial Corp. fell 69 cents to $13.52. The online brokerage that also underwrites mortgages cut its estimate of 2007 earnings per share by at least 25 percent, partly on costs to exit the wholesale-lending business.

NovaStar Financial Inc. lost 78 cents to $7.46. The subprime home lender trying to survive by conserving cash scrapped plans to pay a dividend and said it will forfeit its tax status as a real estate investment trust as a result.

To contact the reporter on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net .

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Yuriy

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Dollar Trades Near Record Low Versus Euro Before Fed Decision

By Min Zeng

Sept. 18 (Bloomberg) -- The dollar was little changed, trading within a half-cent of a record low against the euro, as investors expect the Federal Reserve to cut interest rates today for the first time in four years.

Traders sold dollars earlier as U.S. producer prices fell more than forecast in August, diminishing concern over inflation. The Fed will probably cut the benchmark rate 25 basis points to support the economy, according to the median forecast of 134 economists surveyed by Bloomberg. Japan's currency dropped as gains in U.S. stocks encouraged traders to resume risky bets financed with borrowed yen.

Today's inflation report ``gives the Fed more leeway to be aggressively cutting rates as there is a sign that inflation is under control,'' said Michael Malpede, a senior currency analyst in Chicago at Man Global Research.

The dollar traded at $1.3873 per euro at 12:22 p.m. in New York, from $1.3867 yesterday. The dollar reached a record low of $1.3927 per euro on Sept. 13 and has lost 4.9 percent this year. The U.S. currency touched a 30-year low of 98.01 U.S. cents per Canadian dollar.

The yen fell to the lowest in about a month against the euro and weakened versus the dollar after profit at Lehman Brothers Holdings Inc., the biggest underwriter of U.S. mortgage bonds, exceeded analysts' estimates. The Standard & Poor's 500 Index rose 0.8 percent.

The yen fell 0.6 percent to 115.77 per dollar and 0.6 percent to 160.62 per euro, touching the weakest since Aug. 14. The yen fell against all 16 major currencies.

`Losing Ground'

Lehman's results ``helped alleviate the concern about the credit market,'' said Christian Dupont, a senior currency trader at Societe Generale SA in Montreal. ``Risk aversion is moving down. In this environment, low-yielders like the yen are losing ground.''

The Fed will announce its interest-rate decision at 2:15 p.m. in Washington.

Traders pared bets on a 50-basis-point rate cut after the Lehman earnings.

Interest-rate futures show traders see a 38 percent chance of a Fed cut to 4.75 percent, down from 50 percent yesterday and from 76 percent a week ago. The odds of a quarter-point reduction rose to 62 percent from 50 percent yesterday.

Inflation Risk

Policy makers said inflation was the biggest risk to the economy after they held rates unchanged on Aug. 7. Ten days later, the Fed cut its discount rate a half-point to 5.75 percent and said risks to the expansion had risen ``appreciably.''

A government report showed U.S. producer prices fell 1.4 percent in August, following a 0.6 percent July gain. The median forecast in a Bloomberg News survey was for a 0.3 percent decrease. So-called core costs, which exclude food and energy, increased 0.2 percent.
A Treasury Department report showed foreign buying of U.S. financial assets slowed in July to the weakest pace in seven months to $19.2 billion, compared with $97.3 billion the previous month.

The pound gained against the dollar after the Bank of England loaned 4.4 billion pounds ($8.8 billion) of ``exceptional'' funds at its benchmark rate of 5.75 percent, and said it will offer the same amount of seven-day money on Sept. 20.

The U.K. government yesterday guaranteed customers' deposits at Northern Rock Plc, the mortgage lender that sought an emergency bailout last week. The pound fell below $2 yesterday for the first time this month.

The pound strengthened to $1.9977 from $1.9947 yesterday after earlier dropping to as low as $1.9881.

Yen Quarterly Rally

The yen has gained against all 16 major currencies this quarter as losses from U.S. mortgage securities roiled the global credit and equity markets, pushing investors to trim risky assets. The yen has gained 16 percent against the New Zealand dollar, 8 percent versus the Australian dollar and 6.5 percent against the U.S. dollar during that period.

In carry trades, investors borrow funds in a country with low interest rates and invest where borrowing costs are higher, earning the difference. The risk is that currency moves may erase profits.

Japan's 0.5 percent benchmark rate, the lowest among industrialized nations, compares with 4 percent in the euro region, 6.5 percent in Australia and 8.25 percent in New Zealand.

To contact the reporter on this story: Min Zeng in New York at mzeng2@bloomberg.net .

http://www.bloomberg.com/apps/news?pid=20601083&sid=aCoMfDNvF0V4&refer=currency
 
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