The Fed Underdelivers 21 comments
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The Federal Reserve underdelivered. The futures market was pricing in a 100bp rate cut, but they cut the Fed funds and discount rates by only 75bp.
Even though the US dollar has rallied on the heels of the announcement, don’t expect this strength to last, because the Federal Reserve is playing a dangerous game. With a statement packed with concern about the outlook for the US economy, they are simply delaying the inevitable. What was even more surprising was that two members of the Federal Reserve actually voted for a smaller rate cut.
They should have cut interest rates by 100bp, but they feel that they have done a lot over the past few days and want to leave the door open for an inter-meeting rate cut in case there is another disaster in the banking sector. Inflation is also a problem, which could have contributed to their decision to cut less, but the bottom line is that economic activity has and will probably weaken further due to tighter credit conditions and a deteriorating housing market.
The US dollar is now the second lowest yielding currency in the developed world thanks to the Federal Reserve’s 75bp rate cut. At this point, the Japanese Yen is the only currency that yields less than the US dollar. If the US economy does not recover or liquidity problems do not ease, we still believe that the Federal Reserve could drop interest rates to 1 percent, which would come close to matching Japan’s levels.
Since the last Federal Reserve meeting, the US economy has deteriorated significantly, the US dollar has fallen to record lows, the banking sector is a mess and the fear of counterparty risk has frozen liquidity. This has forced the Federal Reserve to work overtime with new measures announced on a near daily basis. Since February, they:
1. Cut interest rates to 2.25 percent
2. Brought the discount rate down to 2.50 percent
3. Opened up their lending facility to primary dealers (or investment banks)
4. Announced that they will be auctioning up to $200 billion
5. Expanded the collateral that they are willing to take to investment grade debt securities
And, this doesn’t even count the bailout of Bear Stearns or their agreement with JPMorgan Chase to take on $30 billion worth of Bear’s less liquid assets.
With the fear of counterparty risk possibility causing liquidity problems for other banks on Wall Street, the Federal Reserve is still on high alert. Despite the historic move, they will not be able to sit back and relax just because they stepped up monetary easing. In fact, the futures market is pricing in further rate cuts and creativity is vital if the central bank wants to prevent the US from turning into Japan. In the 1990s, Japan fell into 10 years of stagnation after a similarly severe banking crisis.
We expect the US dollar to continue to fall because the band-aids are just not enough – and if anything, this band-aid is way too small. Don’t expect the stock market to take this favorably either because this morning’s 300 point rally was on the hope that the Fed would cut by at least 100bp.
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The problem appears to be that, in spite of super-low rates, if I apply for a mortgage, the bank will still charge me a HIGH rate, based on perceived risk, presumably, in part, the risk that the property I'm buying is possibly worth less than it's worth. What's to stop foreign lenders from stepping up to the plate to compete for all the business US banks are missing out on because they are "excessive caution mode"?
The bank who sold me this CD will then turn around and lend that money to someone for 18-30%.
I'm losing money on that CD (below inflation rate).
The bank is doing quite well with a 14-26% profit (before expenses).
When will the FED help me out?
Thanks. At least I was smart enough not to sell my BAC or JPM. Should have bought more.
If you're worried about the tax advantages of your investments, you're doing quite well.
Not sure about the rate cuts, but the other Fed liquidity measures are very good in my opinion.
The only real option that I've seen is to play for time and hope the private sector can unwind the bulk of it before the Fed has to step in and take the rest onto its books. Once that happens, the only face saving way out is inflation and dollar depreciation -- something that is happening in tandem anyway. Of course, that illusion doesn't really change the fact that the Fed is going to eat something on the order of $500B - $1T to support the system.
The real question is whats the next shoe to drop?
Now the US is the second leader in carry trade stuff (lend your money at a low rate and set it out in countries with a normal rate), why do we not have some scientific research about how long these USA folks will be 'carry trade' folks?
Just like the Japanese were for so long with their stupid monetary policy?
Now?
Cheaper money will not restore counterparty trust or making loans for deteriorating assets more likely. Fisher and Plosser are right, as the continuing fall of housing values and rise of commodities will show. Bottom line is that higher commodity costs will continue to outrun stagnating wages and constrict discretionary cash of the consumer. The slowdown will continue and get worse because the FR and US government will continue doing more of what caused the weak Dollar and high grocery and gasoline costs in the first place.
Fed can fix small problems in the system ("maintain stability"), but problems of the magnitude that we have now are beyond Fed's power to fix.
Only a recession can and will fix these problems. Fed is just providing the pain killers along the way. So that you don't wake up one day to find that your portofolio is down 50% overnight (like BSC investors), but rather that you have time to adjust it (say, put it in commodities) as it slowly loses value a few percent a week.
Proponents of the shock therapy (let it all collapse overnight, it will be over sooner) should remember that a vast number of Americans would not live through the shock, because they don't have the coushin, as some of you do.
Recessions come and go. Relax. Shift your portfolio a bit to commodities and foreign currencies currencies, take a breather, learn Tai Chi, spend more time with your kids, and be happy that you still have something to shift. In about a year maddness will start all over again.
I'm STILL waiting for you to stick your neck out and actually give some direction to investors. I'm sure mom likes the picture but this is hopeless. In light of that..here's something investors might hang onto..
1. The Fed has done what it's supposed to do..provided some liquidity and a financial bandaid to the system. What else was the Fed established for? Go with the flow...
2. It's now committed to the whole nine yards..which means a political solution. That will come from infrastructure..and I mean that in the broadest sense..including oil/gas partnerships and even the Canadian trusts..and frankly..stop reading this crap from Ms. Lien..this is nothing but resume building garbage.
Please also refer to THIS CRAP Ms Kathy Lien wrote moments before the Fed proved all her analysis, predictions and intelligence wrong.
Goldman Sachs would never, ever dare say JPMorgan and friends are counterparties unworthy to deal with, for so long as the sun rises on the right side of the Hudson river. Their greed is to make more money, not eliminate more competitors!
Is this what we get from a 18-year-old graduate of Harvard, Kathy? Ivory tower par excellence from utterly immature baby elephants.
I'm not going to go all Jim Cramer and say today was the bottom (he kinda sounded lonely saying that...). Like the guy above said, go out and play with your kids and come back in 9-12 months for the start of the next bull.
Oil was $24 on inauguration day and Arabia raised output to keep prices down after 9/11.
Alas, the good old aeroplane made by the Wright fellows is but a fuel-gulping monster at 55,000 of thy American gallons full tank. Counting just the 1300 Boeing 747s, that's 71 million in a day of our lord, or ONE billion gallons each fortnight.
Those who would fly after 9/11 came by... in Bear Stearns they buy till the winds blow high.