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Fed rate cut could send interest rates higher!

Our weekly commentaries provide Euro Pacific Capital's latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.
Peter Schiff
Tuesday, November 5, 2002

Foreign creditors could be preparing to slam Greenspan's next rate cut right back in his face. The U.S. dollar has recently fallen to a four month low against the Euro and Swiss Franc, and came close making a 2.5 year low against the Australian and New Zealand dollar. In fact, the chart pattern for the euro projects a short-term move, perhaps over the next 3 -6 months, of up to 1.15 to 1.20. We have also seen recent weakness in longer-term treasuries and home building stocks, suggesting that long-term interest rates could be headed higher.

I believe that there is a good chance that a rate cut by the Fed on Wednesday could lead to a substantial sell off in U.S. dollar denominated debt, causing U.S. interest rates to rise, not fall. This would be a disaster for the Fed as it would signal that it is America's foreign creditors, not the Fed, that control the direction of U.S. interest rates. Once the market correctly perceives this reality, look out. The dollar will fall fast, sending U.S. interest rates and consumer prices soaring. That will kill consumer spending and bust the housing bubble, sending the U.S. economy into a deep recession. A weaker economy will further undermine foreign demand for dollars, sending interest rates even higher, further weakening the economy, creating a self-perpetuating cycle of rising interest rates and economic weakness.

Therefore, this next rate cut may well be Greenspan's last, as falling demand for dollar denominated debt, together with increasing supply from growing government and consumer borrowing, cause Greenspan to raise interest rates perhaps as early as the very next FOMC meeting.