The Hindu Business Line : Fed cut looms large

No longer. When China's stock market tanked last week, the Dow Jones Industrial Average caught much more than a cold. It fell over 400 points - the worst since the post-September 11 crash.

Has China become so important to the US?

After all, the main market for the Asian giant's products is America, with which it is now running a trade surplus of $200 billion.

On the face of it, China seems to be the dependant nation.

But, time has a way of changing everything. China is today not only America's principal trading partner but also a major financier through its investments in bonds issued by the US Government.

For, it has realised that the buck will stop at its table unless it becomes its customer's banker as well. Thus the paradox of the world's richest country borrowing from an emerging economy.

US woes

The US is, of course, having its own problems. The housing market is in a downward spiral. Recent data offer scant comfort or relief to growth optimists. Manufacturing is slowing.

Most other indicators are flashing orange if not red. Asset quality has deteriorated, as credit standards were relaxed in the chase for business and market share in the go-go years, especially for housing.

The chickens are now coming home to roost with a number of the euphemistically called `subprime loans' to doubtful customers turning sour.

Accompanying the stock market sell-off are the resurgence of the extremely low interest rate currencies - the yen and Swiss franc - and the widening spreads on below investment grade and emerging market bonds, validating the oft-expressed recent view that investors are not getting sufficiently paid for risk.

Where will it all end? Mr Ben Bernanke, the Federal Reserve Chairman, is confident the US economy remains on track, though housing is a drag and it is uncertain how far the downturn has to go. The legendary Alan Greenspan says a US recession is `possible, though not probable'.

Mr Bernanke (as well as his FOMC colleagues) still hold out little hope for an interest rate cut. They may well be forced by the present turn of events. For, in recent times, there have been several occasions, particularly in the Greenspan era, when markets have precipitated Fed action.

A massive market crash seems unlikely. However, a US slowdown and tame inflation are on the cards. The Fed could well change the prominence given to inflation risk in the last meetings and suggest a softer interest rate posture.

With inflation fear ebbing and a boost needed to revive the flagging fortunes of the economy, it could feel impelled to cut in the first half of this year itself.

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