Wednesday, January 30, 2008
Fed cuts to 3% - probably more to come
Posted by David Smith at 07:30 PM
Category: Thoughts and responses

The Federal Reserve lowered interest rates for the second week in succession, cutting the Fed Funds rate by half a point to 3%. Its warning of "downside risks" came after official figures showed annualised growth of just 0.6% in the final quarter of 2007. The Fed's statement:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 3 percent.

Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent 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.

Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, 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; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred no change in the target for the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 3 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Atlanta, Chicago, St. Louis, Kansas City and San Francisco.


"Humpty Dumpty sat on the wall
Humpty Dumpty had a big fall
All the king's horses and all the king's men
Couldn't put Humpty together again."

Real rates are negative now, but there's still some fuel left in the nominal rate tank. Is the Fed going to go all the way to zero this time? Could we see zero by the end of 2008? And all this because house prices fell by around 6%! So much for the fabled resilience of the great US (crony) capitalist economy - built on ever expanding credit expansion; asset booms based on fictitious capital; borrowing from foreigners to buy stupid consumer crap; and the rapacious and insatiable appetites of a legislature and executive bent on denying the business cycle it's purifying ebb and flow, while endelssly promoting imperial overstretch.

What happens when house prices fall another 10%? 15%? What will happen when other forms of credit start to go the same way (corporate, prime, auto, credit card) ..... And then Spain and Ireland, the UK, the balkans, and the Baltics join the house price crash party?

'Deflation' is the elephant in the room. Inflation is of no importance now to the Fed (and the way it measured perhaps gives the lie to the fact that it ever was).

The lies of the credit rating agencies, the concealment of the investment banks, and the turning of blind eyes by the auditors stand in the path of financial meltdown.

Whatever happens, it's going to be a close run thing. Exciting times.

Posted by: T Gumbrell at January 30, 2008 10:56 PM

I like your apocalyptic tone, Gumbrell. Keep on foaming at the mouth!

Posted by: bears all at January 31, 2008 10:06 AM

House prices will not fall !

We have learnt by previous mistakes. Inflation is a small price to pay for agressively cutting rates and keeping them high. We all depend on them being high.

Posted by: Pete Balchin, Solicitor at February 2, 2008 12:30 AM

Have you noticed lately (i.e. since February):
- Fed cut rate, the pound falls (-0.5% on Wedn)
- BoE cut rate, the pound falls (that is hardly news)
- BoE keeps same IR, the pound falls (yesterday -1%)

with all my savings in euro, I have already "saved" 12% on the cost of my next house since February. Keep going, titanicuk, iceberg ahoy!

Posted by: Michele at February 2, 2008 04:45 PM

Pete Balchin - so you think that the Bank will follow the way of the Fed. So does Michelle by the sound of it. I'm inclined to agree, but the Bank is holding the line for now.

It is clear that the Fed intends to re-inflate, and re-inflate big time. The Fed will destroy the dollar. It will take nominal rates to zero. It will do anything to prevent a deflationary collapse. Benanke is on record about this. But we must remember that the Fed CAN do this because inflation is only part of its remit.

The Bank on the other hand has its hands tied by its inflation remit. The UK economy is clearly heading towards a house prices crash and ultimately a recession caused by a collapse in consumer spending. BUT, inflation isn't going away. World food prices, energy costs, and (on the horizon) imported inflation from China will make sure of it. So, what is the Bank to do? Well, the givernment could change the way inflation is measured, but that would be a difficult sell, and therefore unlikely.

I suspect that as the credit-based UK economy starts to unravel and the credit crisis worsen (and it is, and it will) we will hear alot more talk about the Bank's overarching goal of maintaining the stability of the financial system as a whole. The Bank will essentially subordinate inflation targeting to systemic stability, and will begin slashing rates. But, first, the government, the media, and the Bank will have to prime the masses for this implicit dropping of inflation targetting. This is perhaps the only way that the authorities can prevent a very serious recession in the UK. Of course, the golden rule will soon go as well - Brown is just working out he he can distance himself from it and present the reversal to the people. As soon as he's got the disinformation strategy agreed, we will see rapid moves to loose the fiscal straightjacket.

Whatever happens, the downward trajectory of the pound is likely to accelerate. Ditto the dollar, and perhaps soon the Euro as well. Watch the value of these currencies against gold - then you will know.

Posted by: T Gumbrell at February 2, 2008 09:49 PM

Sterling's pretty much where it was at the start of the year against the euro and up against the dollar. As for the value of currencies against gold, that tells me nothing, apart from the fact that a commodity has just managed to get back above its nominal price of nearly 30 years ago.

Posted by: David Smith at February 3, 2008 08:50 AM