F&C: US rate cut, market update

Following yesterday's sharp cut in US interest rates, Jeremy Tigue, Head of Global Equities at F&C Investments, has provided an update on the market outlook: "In mid August we took a more optimistic view on equities in the midst of turmoil in all equity and credit markets. Since then equity markets are up and we are sticking with the positions we established a month ago.

Last month we were getting buy signals from several of the quantitative inputs we use which were showing markets at panic levels. This month there are no incremental signals to buy equities and we believe that overall market risk appetite has increased from the extreme risk averse levels reached a month ago. Therefore we are not adding to equities at current levels.

This week has been marked by two significant events:

The first was the run on Northern Rock, a top five UK mortgage lender, and the response from the UK's Chancellor of the Exchequer, effectively guaranteeing all retail deposits in UK banks. This unprecedented intervention should underpin Northern Rock and start to create calmer conditions in UK credit markets.

The second was the 50 basis point cut in the US Federal Funds rate and discount rate yesterday. This was greater than expected and was clearly designed to send a signal to markets that the US central bank, like the Bank of England, would do whatever it takes to prevent problems in the credit markets spreading to the "real" economy.

In the UK and the US, inflation news this week has been slightly better than expected, giving the central banks more flexibility in setting their interest rate policies.

There has been a relief rally in equity markets but we do not think that it will all be plain sailing from here for share prices. There is still serious indigestion in the credit markets, banks have a backlog of debt on their books that they need to clear and private equity takeovers of large companies are either on hold or will take place at much lower valuations. Most importantly, US house prices will almost certainly keep falling into 2008 with potentially serious consequences for consumer confidence and spending. In the UK, mortgages will be more expensive and in shorter supply so house prices here may also come under pressure. US economic growth will slow down in 2008 and the rest of the world will need to adjust to this deceleration in the world's largest economy.

Therefore we believe all markets will be volatile for the rest of 2007 and there will be some high profile problems in individual companies, sectors and markets. However, it is our view that the peak in stress has been seen and that the worst is over."