As you probably know by now, the Federal Reserve lowered both its target Fed funds rate and the discount rate by another 25 basis points today — the second rate cut in the past two months. However, the Fed hinted in its policy statement to the press that it will keep rates on hold at its next meeting on Dec. 11, 2007.
Although the Fed claimed that inflation has improved modestly this year, it acknowledged what most investors and consumers already knew — that rising energy and commodity prices will likely cause inflationary pressures to mount in the coming months.
The Fed also acknowledged what I've repeatedly told our readers over the past couple of months — "the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction."
Stock prices reacted favorably to today's rate cut, with the Dow Jones Industrial Average rising more than 100 points within an hour after the Fed's announcement at 2:15 pm.
However, both gold and oil prices rose to new all-time highs, with gold rising above $796 an ounce and crude oil futures for December delivery rising to $94.50 a barrel.
Meanwhile, the value of the dollar fell to a new low against both the euro and other major world currencies. Hence, most active investors are well aware of the significant inflationary pressures that the Fed has finally acknowledged.
Because of these developments, I'm convinced the Fed is well aware that it's between a rock and a hard place — if it continues to lower rates, the dollar will collapse and inflation will spin out of control.
On the other hand, if the Fed raises rates or just keeps rates at their current level, economic growth in the U.S. will likely slow considerably in the months ahead.
So, I continue to urge you to ignore the Wall Street cheerleaders and to instead focus on the facts. The preponderance of facts strongly suggests the U.S. economy may soon enter a period of stagflation.
Historically, stock prices in general have fallen sharply (for prolonged periods of time) during such environments. Therefore, the path of least resistance for stocks is clearly down.
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