Fed Cuts Rates, Signals Pause; Dollar Down

The Federal Reserve, in a widely expected move, cut the Fed funds rate by a quarter percentage point to 2% on Wednesday. It also lowered the discount rate by the same amount to 2.25%.

From its accompanying statement, one could sense that they are hinting that this cut could be the last one for now, after having cut more than 300 basis points from 5.25% since September last year. This is what the Fed said:

“The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity.”

Words and phrases like “substantial” and “should help to promote” are indications the FOMC is likely to take a break from all the chopping, and sit back to monitor the effects of this monetary stimulus.

What is also worth noting is that two Fed officials did not want rates to be cut at all, preferring the rate to stay unchanged. Those two dissenters are Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser, both of whom also objected to last month’s cut.

Of course, Fed being the Fed, it reassured financial markets that it is going to keep a close eye on the financial-economic situation, saying that “the committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.”

The Fed also added that “financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.” Maybe the worst hasn’t come yet.

As this expectation has somewhat been priced into the market, the US dollar slipped slightly after this rate announcement. EUR/USD rose around 100 pips from 1.5540 to 1.5640 in the half-hour after the announcement. USD/JPY fell around 110 pips post-rate cut, from 104.80 to 103.70.

Comments

[AmesTiedeman]

I think the Fed is done for at least 2 quarters and maybe for the entire easing cycle. If things get very, very bad then the Fed wants to keep some powder dry. Keep in mind, the Fed is very congniscant of the fact that the Greenspan Fed cut too much and then created a housing bubble. Bernanke wants to take a more reasoned approach. However, at 2% on the Fed Funds one has trouble arguing they are being any more cautious than Mr. Greenspan was.

[billddrummer]

The benefits from additional easing would more than likely be outweighed by higher inflation, so there's no upside to more downward movements in short-term rates. Perhaps now that easing is finished, the financial markets can begin to digest the changed landscape, and perhaps restore some normalcy to the credit markets. Normalcy that's been lacking for the last year.

[Voice ofReason]

The Fed actions are like some guy trying to do brain delicate brain surgery through a glove box.

chemistry.wlu.edu/Digi...

I would love to be a fly on the wall to see the goings on behind close doors. Actually I don't have to imagine, I've attended all manner of meetings in my career and just about every one of them was useless.

One of the problems is just about every indicator they look at is trailing or what has already happened. That's like looking out your window seeing cars floating by and then concluding, oh it must have rained pretty hard.

The Fed has a bad track record of doing too little too late. Greenspan though he'll stand on a stack of bible and pretend it wasn't his fault pushed rates too low. Uncle Ben waiting to long to do anything, then seemed to act in panic.

My biggest problem with the Fed isn't so much what they do, rather their curious habit of deliberately speaking in a odd language of their own creation in some feeble effort to try to impress us that they know what they're doing. Nothing could be further from the truth.

Another problem is while the Fed shouldn't get involved with politics at the same time they aren't accountable to anybody either. Every Fed Chairman has has a ego bigger than Detroit which causes them to suffer the illusion they are infallable. Greenspan is the classic example. Worse, the idiots on Wall Street fell over his other to see who could be first to kiss his wrinkled butt. Disgusting!

[icandoitdon]

there is only one part of the fed's statement that worries me:

“the committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.”

they're no better than the u.s. congress and their record proves it.

[Lou Thomas]

Interest rate choices by the Fed can no longer affect the fundamentals that are causing the dollar's decline. Once people realize this, there will be panic selling of dollars.

"Surprises" are presently driving the Euro/Dollar exchange rate, which means that people are engaging in a kind of relative thinking that assumes that all known data has been "priced in" to the present exchange rate, and that therefore any small change in interest rates or growth prospects one way or the other should drive the dollar up or down accordingly.

But all present data has *not* been priced in. This fixation on the fixing of interest rates ignores that there are six trillion dollars in the hands of foreign central banks and others waiting to pour in to foreign exchange markets whenever the dollar gains a little ground.

It also ignores the need of the U.S. government to borrow huge gobs of foreign investors' cash, and the present and increasing reluctance of those investors to put their money into such a lossy currency. With wars on two fronts waged by an anti-tax administration, that borrowing is not likely to abate anytime soon.

If interest rates were to rise under such circumstances, it would only be as an attempt to woo back those who have already fled, or to prevent further such defections. But the continuing decline of the credit-driven U.S. economy will only accelerate once interest rates rise, driving foreign money out of U.S. equities and sending their dollars pouring back onto foreign exchange markets.

Also ignored is the fact that the Fed has eaten through about half of its own (original) $870 billion in reserves with its various lending (read: bailout) facilities. You can pretend that these are loans, but they are backed by CDO wastepaper and will have to be rolled over, so for all practical purposes that money is gone.

What happens when the last gasp of that cash flows into the hands of drunken investment banks to give comfort to those who largely created this mess? What is left at that point but the running of the e-printing presses?

The one truly positive factor for the dollar is, ironically, the deleveraging that is accompanying the collapse of the U.S. financial sector. As these banks sell off everything that isn't tied to the floor to backfill their subprime and other losses, their Euro-based assets in particular go onto the block, and the Euros realized from such sales get converted into dollars on the forex markets to meet these banks' dollar-denominated commitments, providing support for the dollar. Look at the DAX just prior to the present dollar "recovery" and you'll see that it plummeted, following which a bunch of stop limits were probably hit that, along with some trash talking of the Euro, probably amplified that initial dip into the present "dollar recovery."

But once again, pawning all of these precious gems can only go on for so long before Ma and Pa SIV are sticking a fork into their last remaining piece of moldy cardboard. And once these run out, an important temporary support for the dollar (not to mention the U.S. financial sector) will be gone. Well, that is just my theory, so take it with a grain of salt - especially the cardboard part.

Also ignored is the coring out of the U.S. real economy over the past two decades, via NAFTA, CAFTA, APEC, etc. - a process that sent U.S. industry overseas and allowed the resulting cheap foreign goods to be imported back into the U.S., largely causing the present trade deficit disaster. That same coring out of U.S. industry is now preventing an export-driven recovery from being sparked by the falling dollar.

You can't wish decades of such disastrous economic policy away with the turn of an interest rate switch. And yet, here is the financial press (and the markets) hanging on Bernanke's every ear tug and nose scratch, attempting to divine the next interest rate move. Well, who knows? Maybe if we rearrange those deck chairs one more time...

Ultimately, foreign investors, including sovereign wealth funds, will use their 6 trillion dollars to take ownership of a large portion of the U.S. economy. That will cause economic profits from businesses located in the U.S. to be repatriated to other nations, converting dollars to Euros and other currencies in the process, which will redundantly beat down whatever is left of the dollar.

Sorry for the cold water, but that's the world that I live in. If you think it's a different world than the one that you know, then keep investing in the dollar.

[sivere]

The financial system is totally screwed up, because of what the Fed tolerated/encouraged. We need to take back teh Fed, and fix the mess.

TakeBackTheFed.com