The Lag Factor in Rate Cuts

by: Larry MacDonald

Yesterday’s surprisingly aggressive cut of 50 basis points in the U.S. Federal Reserve’s key interest rate caused stock markets to surge, but one thing to keep in mind amidst the euphoria is the historical lag of at least 12 months between interest rate changes and their impact on the real economy. In the next 12 months or so, the lagged and dampening effect of past monetary restriction will likely be more noticeable -- so the animal spirits unleashed by this recent (and possibly pending) rate cuts could be swimming against the current for a while.

With debt climbing steadily relative to GDP in the U.S. over the past several decades, the permabears and other pessimists will likely once again be out in force to claim monetary policy will fail to climb the credit mountain. It always scaled the ever higher peaks of indebtedness in the past and likely will do so again according to the Bank Credit Analyst advisory, but there could nevertheless still be periods over the next 6 to 12 months when doubt creeps in.

In Canada, the Canadian dollar soared yesterday against the U.S. dollar after the rate cut. Economists say it will likely reach parity very soon. This takes a lot of pressure off the Bank of Canada to raise its lending rates. Indeed, it may need to shift toward rate cuts to offset the impact of the runaway loonie. In short, the U.S. Fed’s softening on interest rate policy should be good news for Canadian borrowers, property values, and mortgage rates.

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