Tuesday, January 22, 2008
Fed cuts to 3.5%
Posted by David Smith at 01:50 PM
Category: Thoughts and responses

Ben Bernanke did not even wait until the markets opened. The Fed Funds rate has been cut to 3.5%, getting there several months earlier than expected. Drama indeed. The vote was 8-1, with William Poole voting against. This is what it said:

"The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.

The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

Appreciable downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Eric S. Rosengren; and Kevin M. Warsh. Voting against was William Poole, who did not believe that current conditions justified policy action before the regularly scheduled meeting next week. Absent and not voting was Frederic S. Mishkin.

In a related action, the Board of Governors approved a 75-basis-point decrease in the discount rate to 4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Chicago and Minneapolis."


Was the Fed's meeting an emergency meeting?

If so, is there any chance that the MPC will hold an emergency meeting to deal with interest rates in the UK, which I am sure will have to go down.

It seems to me that only making a decision once a month does not necessarily fit with the workings of the markets, which react on a daily basis and therefore prudent oversight of the markets vis-a-vis interest rates should need to be continually appraised on an day-by-day basis.

Any other business/profession which failed to react to similar large scale developments would be hung drawn and quartered, would they not?

Posted by: Rupert at January 22, 2008 02:08 PM

The minutes of this month's meeting are released tomorrow.

The next meeting is not until 6/7 February which is over two weeks' away.

Posted by: Jack27 at January 22, 2008 02:15 PM


The MPC (or The Fed) don't exist to satisfy the whimsy and caprice of investment banks. Their remit is to control inflation, not to change interest rates willy nilly in line with the exigencies of the stock market.


Posted by: Tom at January 22, 2008 03:03 PM

The fed's remit differs from the MPC, their concern is inflation and with respect to the perceived full natural rate of unemployment. Therefore they are willing to act more decisively in light of economic data showing true recessionary risks. If indeed we see a deflating credit bubble dragging down asset prices - notably property - this process could be long and painful, best to act quickly but expect another 25 - 50bps cut next week! and then to state"action required has been taken"

Posted by: Richard at January 22, 2008 03:33 PM


Although I agree that the MPC should not be seen to panic and/or act at the whim of investment banks, I was asking whether or not anyone thought they would step in early given the dire warnings that have been released e.g. the worst stock exchange performance since 1935, worst UK borrowing record for 10 years and the housing market on a precipice.

In response to your point, I believe the bank should determine itself when it should or should or should not act tothe stock market and currency movements) and ought not be bound to make a decision just once a month. In the circumstances, and as referred to above, I think it would be unreasonable to argue that the current situation did not warrant some decisive action from the BoE whether that be an interest rate cut or an announcement of some sort to give the markets some stability.

It seems to be that in the US, whether it's the Fed or the President, action seems to be being taken to try and head off a recession (whether it works we shall see), whereas in the UK nothing seems to be being said or action taken (notwithstanding criticisms of this policy) ignoring the fact that a lot of experts are suggesting the UK is similar to the US in many ways except that maybe the US is further down the track than we are (in terms of a downturn) and therefore we should perhaps try and avoid the mistakes made in the US and do something now to help try and avoid the position that the US has found itself in.

Posted by: Rupert at January 22, 2008 03:47 PM

Ahha......75bp yesterday, and another 50bp to come next week. If you look at a chart of historic Fed rates you will see two important themes. 1) Fed rate cuts follow the US down into recession. The US is probably already in recession, expecially if a sane measure of inflation was used for the deflator. There is certainly more to come. The market is calling the shots and the Fed is hostage. 2) The point to which nominal rates drop in down turns has got lower and lower each time around. There is isn't much room to go lower than the last time around however when rates were less than 1%.

What we now know for certain is that the Fed doesn't give a hoot about the USD or inflation - 75bp to help out their buddies in the finanacial markets when inflation is very high in the US! It's probably very good news for gold, although it looks like it was already priced in at the begnning of Jan.

The Fed action, and the two themes outlined above, suggest that the Fed rate is going to get very, very close to zero this time round. If they manage to reflate the bubble without going to zero then the US is going to have real interest rates of -ve 4% or thereabouts (or lower depending on your view of official inflation stats) - that's really bad news for savers, and bad news for future inflation. One could almost be forgiven for thinking that the elite in the US want a nation of non-saving debt slaves rather than a balanced economy with a sensible rate of saving! It's very good news for gold and it would be for equities if only we weren't right at the top of an out-of-control earnings cycle.

On the other hand, if the Fed gets down to around zero (and all the signs suggest that this is on the cards), and they still can't inflate that damn bubble again (assuming the fiscal stimulous fails as well), then the US is in very serious trouble (and also the world) - we might then be looking at a nipponesque deflationary spiral.

The middle path doesn't look too likely.

The Bank and the ECB seem to be holding up for now. MK is talking about writing more than one letter this year though - it really is a rock and hard place. Things are about to get so nasty in the UK that the monetary framework itself, along with the way inflation is measured (fabricated) is about to get severly tested. Are we serious about inflation in the UK? Is the Bank really independent? So far yes/maybe. In 2008/9 the reality behind the posturing will be revealed. Gordons golden rule is aslo going to be properly tested, and one suspects it will be revealed for what it is - a farce and a media lie.

Posted by: T Gumbrell at January 23, 2008 11:55 AM

the uk won't follow, even though 0.5% is required by cbi, retailers, etc. It still strikes me that a lot of the uk issues with regard to inflation are self inflicted (ie petrol hikes, utilities, and wage inflation, as well as imminent council tax hikes) are all induced by gov't economic policies of the past decade and track back to mr brown! this lloks like another fine mess.......

Posted by: Colin Flockton at January 23, 2008 12:28 PM

Any which way MK turns there will be criticism, so I suppose the best course for the MPC is to control inflation. In any case if he were to lower IR for the next two meets then the pound would fall and exacerbate an already inflationary market and if he were to hold still then it would be property gloom with prices dampening instead of the pound.

I think the course of action Mr. Brown has started with India and China has to be nurtured and strengthened as fast as possible so as to relieve the markets with positive growth of between 3.0 - 3.5% with the next two years.....meanwhile let there be pain for the next two years or so.

Posted by: Hitesh Damani at January 23, 2008 03:09 PM


Do you think the Feds emergency cut had anything to do with the fact that the Non-Borrowed Reserves of US Depository Institutions turned negative? I am referring to the non-seasonally adjusted data. From an uneducated view point it would seem that some institutions are not meeting their required reserve levels.

What is the significance of this occurring?

Link to the Federal Reserve statistical release;

Posted by: James at January 24, 2008 12:20 AM

Don't know - others may - but something strange has happened at face value in those numbers.

Posted by: David Smith at January 24, 2008 09:15 AM

Non-borrowed reserves at the Fed have gone (down to 200) - another ominous sign??

I think that more and more people are starting to realise now just how big this is. It is NOT a sub-prime crisis. This is what the Fed, our government, and many in the media want people to believe, but it's a misnomer.

The crisis is a generalised crisis of capitalism resulting from a massive and extended mis-pricing of risk thorughout the crony-capitalist system. It is the end of (as Soros said yesterday) a 60 year credit/dissaving binge as well.

If the ratings agencies performed an honest re-rating of all bonds and institutions (esp the monolines), and if the banks' openly realised their true lossess, and if all debt derivative instruments were marked to a real market price, global financial markets would crash, and quite possibly collapse.

It is not about subprime, that's a misnomer, a lulling chant. Next will come the monolines, then credit card and auto debt, then Alt As, and then corporate debt (at ridiculous levels due to the take over boom), later will be 'prime' debt as the asset prices are marked down due to the credit contraction.

The debt fest is over, but the bubble must be re-inflated. How can this be done? If it is not re-inflated soon, then the real value of underlying assets might have to be realised, and if that happens the game is up.

Sorry to sound so apocalyptic, but what started in August 07, is only just getting started, and it is not just a sub-prime crisis.
The Fed knows it, hence the 75bp emergency cut. The Fed is not just trying to overt a hard landing and show the way to a nice soft one. The Fed is staring massive financial dislocation and systemic unwinding straight in the face. The Fed may win out this time, but if it fails it will not be pretty.

Posted by: T Gumbrell at January 24, 2008 12:31 PM

I don't pretend to be remotely an expert on this but it apears to be directly related to the Fed's liquidity operation, which boosted borrowed reserves. We'll have to see how the numbers bed down when this distortion drops out.

Posted by: David Smith at January 24, 2008 12:44 PM


Thanks for your responses on the data I highlighted. Another statistical release that seems relevant is the Net Free or Borrowed Reserve series that shows a large drop in December, nearly as large a drop as the peak in the wake of 9/11.

Link - http://research.stlouisfed.org/fred2/series/NFORBRES

According to Ben Bernanke's recent testimony to the US Congress the recent liquidity operations, through the term auction facility, are intended to stop the banks hoarding money and to provide more credit to the economy. I can see why they would borrow money from this facility to put it to use and earn a greater return. What I canít see is why they would borrow money from the Fed in order to deposit it back with the Fed as their required reserve, after all I wouldnít borrow money from my bank and then deposit it straight back with them. It wouldnít make sense, am I missing something here?

Assuming I have missed something and it is sensible it still doesnít explain a negative non-borrowed amount. The best, and most optimistic, explanation I can think of is that this is equivalent to banks having relatively small amounts of borrowed reserves in normal circumstances. If this is the case then for the duration of the liquidity operations I would expect to see the non-borrowed reserve amount hovering around zero in the coming weeks before rising back to more normal levels as TAF operations are eased back. This data is next released on Wednesday 31st (bi-weekly) and Thursday 1st (monthly) which may prove more enlightening.

$40 billion was auctioned last month and $60 billion is intended for this month, in two auctions on a 28 day basis. Itís too early to draw any conclusions from just two months worth of auctions but a concern on this would have to be that when one monthís auction falls due for repayment it isnít simply rolled over by the next. I suppose this is why the operations are being conducted as auctions, rendering it a gamble for any bank attempting this. Incidentally is the TAF a new innovation or has it been used before?

One last point I would like to make is that the surplus vault cash hasnít changed greatly, if anything going slightly higher, indicating to me that banks are still hoarding.

Posted by: James at January 24, 2008 05:03 PM

James - could the dissapearance of non-borrowed reserves be related to the banks bringing SIV liabilities onto their balance sheets?

Posted by: T gumbrell at January 24, 2008 07:21 PM

I definitely was missing something on the non-borrowed reserves, I didn't think through my analogy properly. It's more equivalent to borrowing money from the bank but still having cash in your pocket to pay out on day to day expenditure (i.e. customers withdrawing money) and as such makes perfect sense. It's not a case of borrowing money simply to deposit it back.

T gumbrell - I agree with David that this is directly related to the Fed's liquidity operations, which in turn I believe are due to SIV and other liabilities being brought onto balance sheets

Posted by: James at January 25, 2008 08:48 AM

Can anyone believe the stories circulating that the rogue trader caused the market chaos, and by implication the rate cut? Honestly these bankers will say anything to prop up the market, and journalists so frequently take the lazy parrot attitude and report the same. There may have been some link, but the sell-off was well underway in Asian markets the night before. Smoke and mirrors.

Posted by: T Gumbrell at January 25, 2008 05:46 PM

One last comment on this, having read up on it a little more (I still can't claim any great knowledge).

The negative non-borrowed amounts that initially shocked me are totally due to the TAF operations of the Federal Reserve, as David suggested. The Jan 16th figures work out as follows;

Total Reserve: 39988
Term Auction Credit (TAF): 40000
Non-Borrowed Reserve: -1389
Total Other Borrowings: 1377

Non Borrowed = Total Reserve - TAF - Total Other Borrowings
(i.e. Non Borrowed = Total Reserve - Borrowed)

These figures are still preliminary so may change slightly.

I'll blame my confusion on the fact that the TAF and Total Other Borrowings are only included on table 1, making it harder to identify what was going on. It wasn't me being slow, no way.

Being optimistic Other Borrowings seem to have peaked with the new year, hopefully heading down as things ease. With increasing amounts being auctioned the non-borrowed figure is going to go further into negative territory. It's impossible to tell from these figures what the Borrowed Reserve figures would be without the TAF. Some institutions will be using the facility because they need to, most because they can.

The latest auction results have just come out with $30 billion being auctioned off at a rate of 3.123%, more than 37bp below the recently reduced Federal Funds rate. Looks like we can expect the fed funds rate to be cut quite sharply again.

What the inflationary impact of the TAF will be I'm not sure, it seems from some of what I've read that the Fed is also draining liquidity via Open Market Operations, but this is something I need to read about further before I jump to any more conclusions.

It's still likely I could have misunderstood some or even all of this so if anyone knows better please correct me.

Posted by: James at January 29, 2008 09:51 PM

One more last comment on this...

The second TAF expired on 24th January, the cut in the federal funds rate and the recent slump in equities occurred in the run up to this date with equities recovering sharply in later trading on 23rd January.

One obvious difference between the first and second TAF auctions is that third TAF took place on the same day the first TAF expired. When the second TAF expired there was a break of four days before the next TAF.

Posted by: James at January 30, 2008 08:54 AM
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