The Fed’s Latest Rate Cut: The Song Remains the Same

Based on some of the e-mails I’ve received, it’s come to my attention that roughly 3 of my 9 readers (that aren’t related to me) would like me to comment on the Fed’s recent rate cut, what it means for the economy, the dollar, commodities, etc, etc. To be honest I was tempted to just cut and paste commentary on past rate cuts, as the situation seems to continue to repeat itself.

From the WSJ:

The Federal Reserve continued its two-front attack on the credit crunch with a steep rate cut, and hinted at more to come.

The cut was less than financial markets wanted. But in a sign the Fed's prior efforts to boost lending through unconventional means may be getting some traction, stocks soared, buoyed by earnings reports from two big investment banks.

The Fed cut its short-term interest-rate target 0.75 percentage point to 2.25%, not the full point that markets had been expecting. It was the largest disappointment the Fed has delivered to markets since the central bank began cutting rates in September. the move was also a signal that because of the Fed's concerns about inflation, it expects its other initiatives to bear more of the burden of stimulating growth.

So the problem (for me) with respect to commenting on the recent rate cuts is that it’s such a repetitive exercise, as in many instances my opinion on the rate cuts hasn’t changed since my first commentary on the matter in September. Granted, things are marked worse this around but a lot of things still haven’t changed:

1. Ultimately this crisis about a bursting credit bubble, poor risk management and bad investment decisions, not high interest rates. Cutting rates may inject confidence, make people feel better or ease pains but it doesn’t solve the core problem.
2. With respect to mortgage relief, the market has effectively ignored the previous rate cuts with respect to lowering mortgage rates, even if this has an effect it would be somewhat analogous to the 1^st or maybe 2^nd rate cut under normal conditions.
3. Holders of ARM mortgages that were on the bubble as far as being able to afford their reset payments may benefit, but I still believe that many ARM holders can only afford to pay their teaser rate payment and anything higher is financially untenable.
4. Continuing on the above, if you have an option ARM your principle is growing as is your interest rate; it’s a double whammy that a rate cut can’t solve.
5. No one at Bear Stearns (BSC) was thinking: “Oh man, if only rates were down to 1% we wouldn’t practically have gone out of business”. No one at Countrywide (CFC) is thinking that they could’ve avoided being rescued by BOA if interest rates were at 1% either.

At the end of the day, the likely scenario is that we’ll see the same pattern from the previous rate cuts repeat itself:

• There is an initial positive response to the rate cut in the capital and debt markets, followed by a letdown and then we’re right back where we started.
• The mortgage markets quickly absorb the rate cuts and mortgage rates barely move.
• More bad news from the financial sector
• The dollar continues its downward spiral, followed by a corresponding surge in commodities prices.
• More calls for a rate cut, Fed intervention, special deals, etc.
• Another rate cut, and the cycle repeats itself.

The rate cuts aren’t really addressing the core issues facing the debt markets and the financial sector, and are turning into a fatuous exercise in attempting to save an economy by debasing its currency. The Fed’s promise to cut interest rates even more in an attempt to “stimulate growth”, should be rephrased as “The Fed is ready to debase the dollar and cut interest rates all the way down to 1%, in order to hasten our economy’s journey along the path to having a ‘lost decade’ like Japan”.

I know, I know, I’m being a grumpy financial Calvinist again.

Sources:

The Wall St. Journal: “Credit Worries Ease as Fed Cuts, Hints at More Relief” – Greg Ip, March 19, 2008.

Disclosure: At the time of publishing the author didn’t own a position in any of the companies mentioned in this article. However, he is quite happy about being able to sneak a Led Zeppelin reference into this article.

Comments

[Manitas dePlata]

The Fed's actions seem so ridiculous, futile and stupid, that one can only conclude the plan is a deliberate destruction of the U.S. dollar and everything that goes with it. My one line description of the Bush Administration is "Malicious intent disguised as bumbling incompetence."
I think the Fed can be safely described in this way. Place bets accordingly and hope you come out of this with one shirt and a roof over your head.