Ben Bernanke’s multi trillion dollar question: to cut or not to cut (interest rates)…

The world awaits with bated breath to see what the US Federal Reserve (technically, the FOMC- the Federal Open Market Committee) will decide in its meeting tomorrow. Chairman Bernanke and his colleagues have a tough call to make. A cut in the federal funds rate of at least 25 basis points is widely expected- and has already been factored into the equity (and debt) markets- not just in the US, but around the world as well. So if interest rates are not cut, equity markets may see even more volatility. Bond markets, though, will probably benefit. But more importantly, not cutting interest rates (or cutting them too late) increases the risk of a US recession. And when the US sneezes, many other economies will catch a cold too.

The recent bad news on job losses/unemployment and generally tight credit (thanks to the subprime lending problem) may impact consumer spending during the year’s most critical holiday season. Autmobile purchase decisions, like holidays, may be put on hold. All this, combined with increasing costs (e.g. on account of the toy industry seeking more stringent tests on itself) may further squeeze margins of companies. And a weak quarter of earnings will only push matters over the edge.

If interest rates are indeed cut as expected, credit supply will improve. However, with oil prices hovering at around the $78/barrel mark and winter rapidly approaching, Mr Bernanke has to take a call on whether cutting interest rates could unleash even more inflationary pressures- something the US economy can do without.

Damned if he does and damned if he doesn’t- boy, I am sooooo glad I am not in Fed chairman Ben Bernanke’s shoes!