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Merrill Lynch analysts urge the Fed to cut rates:

If the inflation-fighting Federal Reserve were to keep rates unchanged to contain price growth — instead of cutting by 1 percentage point in the second half of 2007 as Merrill expects — then this would put the probability of an outright recession in the second half at very close to 100 percent….But if we do end up seeing a recession, then it’s game over: the historical record shows that the average decline in the S&P 500 is 34 percent and the average duration is 37 weeks - more than double the magnitude and triple the duration of classic non-recessionary correction. (March 15, 2007 Reuters)

While I do agree with Merrill that a major decline is on the horizon, I don’t believe that the fed has the power to prevent it. Its true that lowering interest rates encourage borrowing and spending which gives rise to the economy but it is also true that the U.S. is dependent upon foreign countries buying our treasuries and financing our overconsumption and debt. The already weakened dollar would not be able to bear another declining rate environment at current levels. Lowering interest rates puts downward pressure on the dollar and discourages foreigners from buying our treasuries as it erodes their returns.

Below is a long term chart of the US Dollar Index. Notice the level in 2001, when the fed began an aggressive rate cut campaign. The US dollar lost roughly 33% of its value in only 4 years. We are now only a 3 points away from a historic, all time low (Not much wiggle room). Should the fed begin to lower rates, the dollar would almost certainly break below 80, which would not only be unprecedented, but suggest a complete break down of the dollar to much lower levels. This too, would be game over. Imagine the ramifications if global investors diversified $1 trillion (roughly 10% of our external debt) out of US Dollar? It would be Peso Time for the dollar!

usd

The Market

Financial stocks continue to slide indicating trouble ahead. Brokerage, Bank and Financial stocks are good leading indicators of the stock market and overall economic backdrop. The following charts all tell a similar story. We see major breakdowns on heavy volume, dead crosses between the 50 day and 200 day moving averages (Bearish sell signal given when the blue line crosses under the red line), and each trading below both moving averages. These 8 stocks represent the health of our financial system. The recent price movement suggests a trouble ahead.

American Express
amx

Bank of America
bac

Morgan Stanley
ms

Bear Stearns
bsc

Citigroup
c

JP Morgan
jpm

Merrill Lynch
mer

Wells Fargo
wfc

The broker-dealer index still sliding and has taken out the 200 day moving average.

xbd

Below is a chart of the Dow Jones Industrial Average. MACD and RSI indicators suggest more downside. Any short term rally should be met by sellers at the 12,361 level. Next downside price target lies at 11,850.

djia2

S&P500 looks similar. Short term rallies should fade at 1408. Next downside price target is 1373 which coincides with a 50% retracement.

spx

Resistance for the NASDAQ lies at 2400 with 2277 as the next downside price target.

nasdaq

Next two charts are the advance-decline lines of the NYSE (Chart A) and the Nasdaq (Chart B). This is simply a measure of the number of up stocks minus the number of down stocks. It can be a very useful gauge of the market.

Chart A

Here we see a major uptrend, which began at the start of the summer rally, violated.

advancedecline

Chart B

The NASDAQ shows a sideways movement over the past few months, but has recently taken out a key support level.

ndxadvdecline

Two weeks ago I pointed out two stocks which looked particularly vulnerable–Exxon Mobile (XOM) and Microsoft (MSFT). While it has only been two weeks, it’s worth pointing out that Microsoft has lost $2 in value, while Exxon Mobile has remained at about the same price(But deteriorating further).

Microsoft may rally back to $28 or so before heading lower. Price target 1 lies at $25.40

msft2222

Exxon looks like it’s about to fall sharply. Though prices have remained the same since my post or 2 weeks ago, the RSI dropped below 50 last week while momentum continues to roll over. Watch out!

xom22222

Disclosure: Author has no position in the above-mentioned securities.

Source: Decline is on the Horizon: Why Even The Fed Can’t Save Us Now