Fundamentals lead the charts

The day after the Jan. 21 Martin Luther King national holiday in the U.S. — a day when global stock markets melted down approximately 5 to 7 percent — the Federal Reserve cut the fed funds rate a whopping 75 basis points (bp), which was the first 75-bp cut since 1984. At the time of the announcement (around 8:20 a.m. ET), stock index futures were down a lot, essentially predicting the U.S. stock market would tumble 5 to 7 percent, too.

The Fed cut rates to enhance the probability of a short and shallow “drive-by recession.” The announcement’s “emergency” timing, though, has to be connected to the global stock market crashes the day before. In short, the Fed seemingly cut rates to avert a really bad day on Wall Street. As a nod to stock market woes, the Fed may have added an additional 25 bp to the 50 bp already priced in by the market for the scheduled meeting a week later on Jan. 29-30.

Because an emergency inter-meeting rate cut — and such a big one — is not consistent with what we know about central bank attitudes toward asset markets, we have to wonder what the Fed knows (or suspects) that the rest of us do not. And if the Fed is so concerned about equity prices, what is its level of concern for the dollar?

There are some clues in the data that lead us to a balanced perspective on why the Fed acted as it did and what it means for the dollar over the next few weeks and months.