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Economics: To Raise or Not Raise?
New York: May 30, 2004
By John R. Stephenson

With the recent backup in the yield curve, the market seems to be anticipating that the Federal Reserve will have to raise interest rates in the near future. The US economy appears to be chugging along at quite a clip, complete with low inventories and strong retail sales which have helped to boost productivity and job creation. All of this has made investors wary that a rate hike is just around the corner — and we are inclined to agree.

Even though there will be tremendous pressure on the Fed to boost rates to cool off what would appear to be an overheated economy, there are at least a few reasons to pause. For starters, a lot of the inflationary pressure we have been witnessing has been driven by high energy prices which are likely to cut into consumer spending in other areas. As well, the stimulus effect of the tax cuts is waning and higher mortgage rates will trim housing activity later in the year. Mortgage refinancing is already off significantly and the effects of this lower mortgage refinancing should start to show up later in the year in the form of reduced spending on autos and other consumer goods.

Higher interest rates would support the US dollar which appears to have resumed its weakening trend against all of the major currencies. But our predictions indicate that the US currency must weaken to help mitigate against an astronomical rise in the country's current account deficit which could swell to $1 trillion over the next four years if the US dollar doesn't decline further and the economy expands more rapidly than that of its key trading partners’ economies. The next trade report is due out on June 11 and should be widely watched and followed by traders.

Although the trade numbers which come out in little more than a week's time will likely show a further weakening of the current account (the previous trade report showed a record monthly trade deficit of $46 billion), a strong jobs report (due in early June) will likely put pressure on the Fed to raise the rates. With a growing chorus of market observers suggesting that the Fed is behind the curve, we expect that the Fed will likely raise interest rates 25 basis points (0.25%) in June and then another 25 basis points in August. In our view, the rise in interest rates will be less than the consensus view because the Fed is aware that without huge capital investment inflows into the US, the only practical way to reduce the effect of the current account deficit is to let the currency slide.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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