How Much Ammo Does the Fed Have Left?

How much ammo is left in that Fed funds gun?

Interesting reaction yesterday at the Chicago Board of Trade to the Fed's decision to reduce its target for the fed funds rate by 75 basis points to a new objective of 2.25%. On Monday, the fed funds futures contract had been anticipating an average funds rate of 1.95% for April, consistent for example with a 100 basis point cut yesterday and some weakness prior to another 25 bp cut at the April 29/30 FOMC meeting. However, after yesterday's meeting, the implied April interest rate shot up 20 basis points to 2.15%. The Fed made a big cut, and the market was surprised that it wasn't even bigger.

To put these numbers in perspective, prior to January of this year, the Fed had not made a cut as large as 75 basis points in a single move in the available 25-year history of the series. And yet now we've reached a point where we're surprised when the cut is "only" 75 basis points.

Still, I am glad to see that the Fed recognizes the need for at least this much restraint. I say that not because I am still mechanically thinking about a tradeoff between promoting real GDP growth and containing inflation. I think we are past that now. I could easily imagine this weekend's developments with Bear Stearns as only the initial carnage in what may prove to be a very bloody financial crisis. I accept the view that job 1 is to try to contain that damage.

But suppose you believe that oil over $100 a barrel is a destabilizing influence-- and I do-- and that the Fed's recent decisions on the fed funds rate are the primary reason that oil is over $100-- and I do-- and that further reductions in the Tbill rate have limited capacity to stimulate demand-- and I do. Suppose you also saw a risk that the inflation, financial uncertainty, and slide of the dollar could precipitate a run from the dollar, introducing an international currency crisis dimension to our current headaches.

Well, if you did, then even if you were very, very worried about our current financial problems-- and I am-- you would still want to draw the line somewhere, and acknowledge that there is some point beyond which lowering the fed funds rate further will do more harm than good. When we've got that rate to 2.25%, and people are telling surveyors they are expecting 4.5% inflation, we need to be open to the possibility that we've already reached such a point.

I think the Fed missed an opportunity here. A 25 or a 50 basis point cut would have sent commodity prices crashing. Even the mildly hawkish surprise of "only" a 75 basis point cut may have some effects in that direction. If the Fed did convince the commodity speculators that their path leads only to ruin-- and I believe the Fed could easily have done just that-- that would leave Bernanke with a lot more maneuvering room to cope with what comes next. If the commodity demon were under control, maybe we'd have the breathing room later to bring the fed funds rate all the way down to 1%. While the speculation remains rampant, however, I expect to get nothing but trouble for the effort.

The Fed is firing its gun into the air. We may soon really wish we had some more ammunition.

Comments

[CarlosSlim]

During the Depression, interest rates on savings accounts went negative, so savers actually paid the banks money for the privledge to put their money there.

I'd say the FED can go negative now, too.

So, the ammount of ammo left depends on the willingness of the Merkin Sheeple and China to go negative for the "safety" of the US of A.

[SeriousBull]

I agree the Fed missed an opportunity. They continue to address the liquidity need falsely assuming that in time the extra credit and spread will address the solvency issue. Indeed the Fed fails to recognize that these losses are real and big. Securitization and Leverage is amplifying the liquidity crisis and I doubt the Fed has time on it's side to wait out the solvency crisis looming. Today's rule change to let Fannie Mae and Freddie Mac lower their capital reserve requirements is a good move to expand the buyers for these mortgages, but the bottom line is that they are not worth 100 cents on the dollar and again, it is highly likely that the reality of the lack of buyers in the market place will trump the attempt to sugar coat reality.

[clitosil]

Just wait until the middle eastern oil producers depeg their currencies to our infamous dollar. The big question is: What is the real basis of value?? Also, what happened to all those senators and congressmen clamoring for China to depeg? Heh, what a mess.

[MattBlackman]

You missed to mention that in its many bailouts to date, the Fed has blown $400 billion of a total in available assets to the quasi government institution of $800 billion. At the rate it is currently going given that we are early in this meltdown (the real challenges will begin when the election is over in 2009 if history is any guide) the Fed will be out of ammo and shooting blanks by Q3 to Q4-08 just when the economy will really need the most help.

[Alpha Seeker]

"The only people making a coin at the moment are traders.The market is circling around the 1300 level (SP500) like a drunk Egyptian fly begging to be knocked out." Rob Ivanoff WallastonInvestments.c...

[woody8]

Finally someone talking some sense. I wondered when people were going to start worrying about the oil price and the dollar drop. By the looks of things, the market agreed since, after the initial drop, the market rebounded even though they did not get the expected 100 basis point cut they were expecting. As a foreigner, I think the rest of the world is more worried about the plummeting dollar than Bear Stearns. If China and Japan give up on the dollar and liquidate their dollar assets, then that will make Bear Stearns look like a Sunday afternoon stroll in the park.

[Tie D]

Enter your comment hereThe FRB are idiots for trying to save these banks. Thank goodness for them, that the American taxpayers are bigger idiots.

The US Dollar Index traded at 76.156 less than a month ago. Due to the Feds' slash and burn policies, it was 71.198 yesterday.

That is a 6.5 percent drop in the value of all US currency. Given there is about $820 billion dollars of U.S. currency in circulation, that means that $53 billion dollars in wealth was destroyed for the sake of Lehman (a $30 billion company) and Bear, which for all intents and purposes is on life-support anyway. I don't even know where to start in calculating the loss in value of hard assets that are also valued in US Dollars.

Get ready for massive inflation, because once again, we all pay so that a greedy few large investors don't lose their assets.

Its better to stop messing with policy, and allow investors to take their medicine, than ruin an entire economy.

[Tie D]

Two more cents... Jim Rogers had it right:
video.google.com/video...

[Tony Soprano]

Since there is so much angst directed toward the Fed and the US Government, I decided to listed some events, not all of them, that had dramatic ramifications on lives, cost and the psychology of our country. I started in 1906 because it’s just a little over a hundred years. As I compiled the list, I could not help but feel the great sacrifices that many American’s have made and what a resilient country, economy and government we have in American.

The 1906 San Francisco Earthquake and fire, registered 8.25 on the Richter scale; estimates range from 700 to 3,000 dead or missing, approximately 225,000 injuries and $400,000,000 in 1906 dollars.

Recession, May 1907-June 1908, 13 mo

Recession Jan. 1910-Jan. 1912, 24 months

Completion of the Panama Canal, 1914 – 27,500 workers are estimated to have died

Recession Jan. 1913-Dec. 1914 23 months

World War I -- 116,708 killed – 33 billion

Spanish influenza, 1918, killed over 500,000 people in the worst single U.S. epidemic.

Recession Aug. 1918-March 1919 7 months

Recession Jan. 1920-July 1921, 18 months

Recession May 1923-July 1924 14 months

Recession Oct. 1926-Nov. 1927 13 months

The Great Mississippi Flood of 1927, flooded 27,000 square miles, 246 killed

The Great Depression, Black Tuesday, crop prices fell by 40 to 60 percent, after the panic of 1929, and during the first 10 months of 1930, 744 US banks failed. (In all, 9,000 banks failed during the 1930s). By 1933, depositors had lost $140 billion in deposits.

The Dirty Thirties, longest drought of 20th century. Peak periods were 1930, 1934, 1936, 1939, and 1940. The "dust bowl" covered 50 million acres in the south-central plains during the winter of 1935-1936.

Labor Day Hurricane of 1935, 400 killed

Recession May 1937-June 1938 13 months

World War II – 408,306 killed – 360 billion

Wartime Controls: 1941-1945 rationed consumer items ranging from sugar to gasoline

Recession Feb. 1945-Oct. 1945 8 months

The Marshall Plan, July 1947 – 13 billion in economic and technical assistance were given to help the recovery of the European countries

Recession Nov. 1948-Oct. 1949 11 months

Korean War, July 1951 - July 1953 – 33,000 killed in action

Recession July 1953-May 1954 10 months

Recession Aug. 1957-April 1958 8 months

Recession April 1960-Feb. 1961 10 months

The Cold War, some estimates shows $8 trillion was spent, worldwide, on nuclear and other weapons between 1945 and 1996

The Cuban Missile Crisis, Oct. 1962

Good Friday Earthquake (1964) In Alaska, it was the fourth biggest earthquake recorded

Vietnam War, 1963 – 47,378 killed in action

The murder of JFK, 1963 Nov

The Gulf of Tonkin Incident, Aug 1964

The murder of Dr King, April 1968 and Bobby Kennedy, June 1968

The city riots of April, 1968 – 30 cities affected

Hurricane Camille, Aug 1969, 259 killed

Recession Dec. 1969-Nov. 1970 11 months

Stagflation of the 1970s began

Nixon first imposed wage and price controls on August 15, 1971

Oil Embargo, Oct 1973 long gas lines

Recession Nov. 1973-March 1975 16 months

Articles of Impeachment of Nixon started
(Approved by a vote of 27-11 by the House Judiciary Committee on Saturday, July 27, 1974.)

Deregulation: 1974-1992 this era began when Nixon left office

Three Mile Island nuclear power plant crisis, March 1979

Mount St. Helens eruption 1980

Recession Jan. 1980-July 1980 6 months

Prime reached unbelievable 20% in January 1981,

AIDS was first reported June 5, 1981 by the government – It is thought that more than one million people are living with HIV in the USA and that more than half a million have died after developing AIDS.

Recession July 1981-Nov. 1982 16 months

California earthquake 1983

The 87 market crash - Black Monday

California earthquake, 1989

Recession July 1990-March 1991 8 months

Iraq invaded Kuwait on August 2, 1990

The Persian Gulf War, 1991 or Desert Storm Jan 1991

Hurricane Andrew 1992 very destructive United States hurricane

The Great USA Flood of 1993

Intervention in the Former Yugoslavia,

Dot Com Bubble, climaxed on March 10th, 2000 with the NASDAQ peaking at 5132.52

9/11 Attack, 2,974 people died

Recession March 2001-Nov. 2001 8 months, Airline Industry Collapsed

Enron bankruptcy in late 2001, employed 22,000

WorldCom, July 21, 2002, filed for Chapter 11

Iraq War, March 19, 2003 – 4,000 dead

Hurricane Katrina, late August 2005, 1,836 people lost their lives

Start of the Great Housing Recession or Sub-prime Recession 2006 or 07, 08? Date to be determined.

[pharma]

"During the Depression, interest rates on savings accounts went negative".

Well, it did not do any good stopping and/or shortening the Depression. All FDR initiatives led to nowhere. The currency crisis and overproduction capacities brought the great depression.

Only the WWII and devastations it brought allowed the world economy around the globe to start a new economic recovery.

The efforts by the US Treasury and the Feds to support artificially-high housing prices and get rid off mountains of debts through inflation are condemned to a grandiose failure.