No Rate Cut Expected

Consensus view is that the Federal Reserve will cut the federal funds target rate to 0.50% from 1.00%. I see a significant chance that there shall be no change in policy. Here is why:

It's the Yield Curve

Today the yield curve is steep. Even with the target fed funds rate of 1%, the 1 month yield has ranged between 0.00% to 0.09% during December. During this period, the 20 year yield has ranged between 3.35% and 3.51%.

A further decline in the feds fund rate is very unlikely to move the long end of the yield curve. It is senseless to make changes to policy which are incapable of attaining their objective. The yield curve is normally steep just prior to an economic recovery; this causes credit expansion which ultimately leads to recovery.

However, in the present economic landscape there is no meaningful credit expansion. I believe unconventional policy measures undertaken by the Fed at the long end of the yield curve constitute a better policy response compared with a reduction in the target federal funds rate.

The ability to cut rates once the credit markets at the long end of the yield curve are resurrected will be a far more powerful policy tool than a rate cut now.

At this point in time, clear indication that policy will remain accomodative is what is required. Any hint of a restrictive policy going ahead would be bad news. For policy to remain accomodative, it would be good to have ability to cut rates in the future.

Comments

[Asbytec:]

How dare you go against the expectations? Bravo! :)

I honestly hope you're right about them not cutting, because I believe you are exactly right about it's ineffectiveness at this point.

I guess we'll see in a couple of hours. I am actually glued to the tube awaiting the news.

2008 Dec 16 10:27 AM

[patio:]

Good call

2008 Dec 16 03:10 PM

[Socialism c...:]

Wrong. And here's why you were: because qualitatively, the rates were already behind actuality. Your hypothesis that the Fed should act on the longer-term end of the curve is invalid -- the credit concerns have to do with short-term financing.

2008 Dec 16 03:11 PM

[Moon Kil Woong:]

LOL you missed 1 thing in your analysis. You left out the fact Bernake is stupid stupid stupid and thinks the only way out of a crisis is make funny money and dump it in a big bankers playground so they can swim in it until their hearts are content enough to think the world is "fantastic".

2008 Dec 16 10:33 PM

[Bunnynose:]

hmm. It's too bad you were wrong. I think your logic makes a lot more sense than what they did today. They already own the banks and have been secretly financing at .18! What more do the banks want? There is no point to this cut.

2008 Dec 16 11:05 PM

[bearfund:]

You were absolutely right in the sense that changing the supposed target rate will have no effect. But that's only because the effective fed funds rate has already been in the new "range" for some time.

Reducing long rates serves only to make the dollar even less attractive to people who still mistakenly believe that it is a store of value. That will make it increasingly difficult to attract investors to the US and make it difficult to keep domestic savings at home. The next policy change will be capital controls to counteract these forces. I suspect we've crossed the Rubicon now and nothing the Fed or anyone else can do will prevent hyperinflation.

2008 Dec 16 11:17 PM