Last week's 50 basis point cut revived fears of a surge in inflation as it took place in an environment in which commodity prices are surging and the dollar continues to weaken. This is evident in the yield curve, which, from the beginning of the year has shifted from being inverted to becoming normal or upward slanting. It would suggest that the market is pricing in a future surge in inflation. But it is not as straight forward as it seems because we are in a precarious environment of recovery from the subprime/short term liquidity shock. The Fed's use of the federal funds rate, the most prized weapon from its arsenal of instruments, leaves it with fewer tools with which to manage the crisis. The worry is that this 50 basis point cut may not suffice given the downward pressure that would arise if consumers battered by shrinking home prices and higher gasoline prices decided to cut on spending, prompting further cuts by the Fed.
On a side note, the crisis may be providing an opportunity for buyout activity and we are seeing signs of this with the news that Warren Buffet may be looking into purchasing a stake of Bear Stearns.
