Stocks may rise on expected interest rate cut

By Herbert Lash

NEW YORK (Reuters) - Wall Street expects Federal Reserve policy-makers to cut interest rates next Tuesday to help ease a global credit squeeze, a much anticipated event that spurred stock prices higher this week and could boost them next week.

Investors expect the Federal Open Market Committee to cut the federal funds rate in response to growing concerns that the U.S. economy is slowing and may be heading into recession.

Short-term interest rate futures on Friday indicated investors believe a half a percentage point cut in the federal funds rate is slightly more likely than a quarter percentage point cut when the FOMC meets.

Some investors say the stock market has priced in a quarter-percentage point rise, limiting any upside. But if the past is a guide, investors will react to the actual event, said David Bianco, chief U.S. equity strategist at UBS in New York.

"I think the market's going to have a positive reaction to it, I really do," said Bianco, who expects a 25 basis point cut in the federal funds rate and a 50 basis point cut in the discount rate.

"It will signal a response to what's going on, to try to prevent credit market troubles from spreading to the real economy," he said.

Reuters polls showed on Thursday that economists see about a 30 percent chance that the United States enters recession in the next 12 months should the effects of a housing slowdown continue to seep into the wider economy.

Major U.S. stock market gauges moved up this week in anticipation of a rate cut, with the Dow Jones industrial average .DJI posting its best week since April.

For the week, the Dow rose 2.5 percent, the benchmark Standard & Poor's 500 Index .SPX gained 2.1 percent and the Nasdaq Composite Index .IXIC rose 1.4 percent.

On Friday, the Dow closed up 17.64 points, or 0.13 percent, at 13,442.52; the S&P 500 closed up 0.30 points, or 0.02 percent, at 1,484.25, and the Nasdaq closed up 1.12 points, or 0.04 percent, at 2,602.18.

OPTIONS EXPIRATION TO STIR VOLATILITY

Investors will want to see if the subprime mortgage trauma has worsened for four big investment banks -- Lehman Brothers LEH.N, Morgan Stanley (MS.N), Bear Stearns Cos. Inc. BSC.N and Goldman Sachs Group Inc. (GS.N) -- when they release fiscal third-quarter earnings results over three days next week.

The release of third-quarter earnings for most companies doesn't begin in earnest until October.

The banks have diversified business models and are able to profit from worldwide economic growth, which will alleviate any downdraft of credit market issues, said Michael Cuggino, chief investment officer of the Permanent Portfolio family of funds in San Francisco.

"We may be surprised to find the negative impact was not as great in the third quarter as people may have expected," Cuggino said.