Five Reasons Why the Fed Will Cut Rates
Late August, we reviewed Marketbeat's Five Reasons Why the Fed Won’t Cut Rates.
At the time, we noted they would present the opposing arguments.
Today is that day: Here are Five Reasons Why the Fed Will Cut Rates, according to WSJ's Marketbeat:
1. Inflation isn’t out of control. The core personal consumption expenditures price deflator rose at a 1.9% annual rate in August, inside the Fed’s assumed preferred range for the rate of inflation (1% to 2%);
2. Market conditions are still problematic. The asset-backed commercial paper market remains knotted and credit spreads in high-yield markets have widened out;3. The market is expecting it. While the Fed isn’t one to necessarily respond to bile-spewing yahoos on television demanding rate cuts, it isn’t in the habit of ignornig the market as a practice.
4. The housing market’s troubles warrant it. In Jackson Hole, Fed governor Frederic Mishkin presented a scenario imagining a 20% decline in real house prices, and suggested that faster, sharper cuts in the Fed’s targeted rate would minimize the impact of such a downturn.
5. They have little to lose. “Two or even three sequential ¼ point cuts will not create a re-kindled gambling spirit,” writes David Kotok, chief investment officer at Cumberland Advisors in Vineland, N.J. “Thus the Fed can cut without violating its proper concern about ‘moral hazard.’”
My view of this?
Numbers one and two are quite valid; number three -- the market wants/expects it -- is irrelevant. Number 4 raises a problem that rate cuts won't really help -- the housing market is in trouble. Number 5 is pure unadulterated bullshit fiction.
Go read the full post.
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UPDATE: September 4, 2007 8:44pm:
LOL -- No no no no no!
That's marketbeat's views, not mine. Since I posted their 5 reasons the Fed WONT cut, I wanted to include this version so readers could see the other side of the argument,
My view on inflation: its much higher than has been reported, and is being driven by a weak (over-printed) US dollar, and insatiable demand from China and India.
As the US economy slows, inflation should subside to more moderate levels -- still elevated, but more moderate than the past few years.
The quoted section is from the Marketbeat, and it is mathematically valid -- that is in fact what the reported core inflation numbers are. As the comments point out, you already know what my view on core inflation is . . .
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Source:
Five Reasons: Why the Fed Will Cut Rates
David Gaffen
WSJ, September 4, 2007, 3:14 pm
http://blogs.wsj.com/marketbeat/2007/09/04/five-reasons-why-the-fed-will-cut-rates/
Tuesday, September 04, 2007 | 05:18 PM | Permalink
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I can see why #4 has meaning and to me is really the only reason listed to warrant a fed cut ahead of the curve to help cushion any problems later on with a slowing economy.
#s 3 & 5 are really totally pointless.
I just don't see how the fed can cut rates given:
1. Stock markets are only 600 points from record highs
2. Global economies are still very strong and global central banks are not even considering cutting; unless I'm missing a few recent changes?
3. US dollar has little support and will lose more ground with rate cuts.
4. Jobs still not showing serious deterioration that warrants a rate easing campaign.
Let the markets price in the rate cut. That in itself helps with confidence and the process of free markets working themselves out. We still dont know what we are dealing with here or the ultimate effects on the economy.
I think we have future cuts in discount window before we have fed funds target cut. When economy shows signs of distress, they will have that weapon to use, which is lagging anyway in its real effects; forget initial psychological effect.
I just dont see any aggressive rate easing this year. Maybe 1/4 - 1/2 point max by years end, if that.
Posted by: UrbanDigs | Sep 4, 2007 5:31:18 PM
Bile-spewing yahoos? That's harsh. Accurate, but harsh...
Agreed, all the way through. The worst part is the dilemma's horns - while the economy may genuinely require a rate cut in order to stave off a recession that seems to loom larger each week or two, the perception of far too many financial market participants will be that Ben and Friends will come riding to the rescue no matter what. Like Garrett Hardin once said, "You can never do only one thing..."
Posted by: Uncle Jeffy | Sep 4, 2007 5:32:45 PM
WHAT??
Barry - you're now saying,
" Inflation isn’t out of control. The core personal consumption expenditures price deflator rose at a 1.9% annual rate in August, inside the Fed’s assumed preferred range for the rate of inflation (1% to 2%)"
This is news. You have blogged quite a bit to the contrary.
I, of course, agree with your new opinion.
~~~
BR: That's not me, that's the WSJ marketbeat speaking. (I'll make it clearer up top)
My view on inflation: its much higher than has been reported, and is being driven by a weak (over-printed) US dollar, and insatiable demand from China and India.
As the US economy slows, inflation should subside to more moderate levels
Posted by: Fred | Sep 4, 2007 5:33:35 PM
6. Because we all know that the best way to cure a hangover is to drink another beer.
Posted by: KP | Sep 4, 2007 5:35:14 PM
Fact is, it may take a 20% or larger decline in home prices to make them "affordable" and clean up the inventory. Hey, it's a basic tenet of retailing. Price moves product. The huge overhand of empty housing units will not move until the economics are right. When something goes up 100-300 percent, what's the problem with a 20% decline? Elementary Econ 101 in action.
Posted by: stan | Sep 4, 2007 5:36:42 PM
Haven't you heard? Exports are gonna bail us out. Yep, we're gonna sell enough airplanes and tractors to stave off the recession - no rate cuts will be needed. Caterpiller and Boeing will be generating thousands of new jobs to replace those now being lost in the new world order. Right, Fred?
Posted by: Sweeny Texas | Sep 4, 2007 5:45:41 PM
urrfullasheeitassachrisssmassgoose.
Posted by: Eclectic | Sep 4, 2007 5:47:54 PM
Given that the ECB has been foreshadowing a rate increase, I don't see how the fed can cut without further dollar erosion. This doesn't mean that they won't cut. Regardless, the Fed has limited ability to effect mortage rates when the present restructuring of rates has little to do with comparative advantage and more to do with a normalization of risk premiums.
Posted by: M.Z. Forrest | Sep 4, 2007 5:52:22 PM
What would we rather have happen: (a) a little bit more inflation that hurts consumers' purchasing power or (b) a 20% drop in home prices and a reduction in business activity?
Who here wouldn't prefer another bubble over depression?
I think the Fed will cut rates and assets *other* than homes will march upwards. It's the path of least immediate pain.
Right said Fred?
Posted by: wunsacon | Sep 4, 2007 6:38:05 PM
The first point seems far from obvious to me.
I know that some people (and almost everyone with any role in government) are convinced that the core CPI means something. Most arguments I have heard in favor of such convictions focus on the academic arguments over the virtues of hedonic adjustment and geometric weighting.
However, there are other important arguments to consider. Among these is (not so) simple comparison between inflation today and inflation in the past. It has long been in the interest of government to support the branch of academic economics that believe the CPI to be overstating inflation, and thus adjustments have been made to the measure over time. In order to compare inflation in one period to inflation in another we of course have to use the same methodology. The government doesn't publish what inflation rates would have been with using prior methodologies, but fortunately this gentleman does:
http://shadowstats.com
His calculations show that inflation using the pre-clinton methodology would currently give us an inflation rate of around 5% per y/y. That is much higher than both core and headline inflation as they are measured today. If he is correct, interest rates are now significantly lower relative to inflation than they have been in the past, as interest rates are measured exactly as they always have been.
This in my opinion has disconcerting implications for the future of the value of our money, especially in the event of even further easing.
Posted by: Andreas Stover | Sep 4, 2007 6:44:06 PM
I think we get caught up too much in the definition of inflation and its relevance in the big picture. What matters is that wages are stagnant, job losses will soon be mounting, consumers are up to their eyeballs in debt, home prices are going to drop at least 20%, and we'll be damn lucky if we don't have a full blown depression.
The Fed is gonna cut the fed funds rate like there's no tomorrow in order to lower the funding costs of the too-big-to-fail banks. This will slightly offset the billions in losses they are fixin' to take with the impending housing collapse.
But, it will be like peeing on a wildfire.
Posted by: sweeny texas | Sep 4, 2007 7:08:43 PM
"Inflation isn’t out of control."
That's if you take CORE inflation, i.e. without food and energy, by chance the most essential items for life. Have a look at oil, wheat and milk, not to get fancy. In oil, with specs having liquidated almost all their net long positions, the price couldn't break 70 and it's back at 75. Wheat has just gone vertical to unchartered territory, without much spec involvement. Milk has gone up by 50%/100% (class III/nonfat dry) in the last year to record levels.
So, as long as you don't eat, drive, or heat your home, yes, inflation is well under control.
Posted by: Commodity Trader | Sep 4, 2007 7:12:00 PM
Pure Jawboning!
Give me the position you want to support and I will give you 5 totally convincing and irrelevant data points and arguments.
There is roughly a trillion dollars in debt out there that is Underpriced. Meaning that the losses on the loans will exceed the loss reserves that were priced when these loans were made.
There is no way to fix that. You have to let the markets play out the losses.
This non stop waving of the chicken bones and clever financial engineering just brings us more problems. This is a simple case of musical chairs. We would be much better off if we would just accept that there are not enough chairs to go around.
If we don't face up to the core issues we will push the coming recession from a small one to a large one. Plain and simple.
Posted by: Ralph | Sep 4, 2007 7:25:25 PM
On another point.
ON one hand everyone seems to be blaming the Fed for keeping interest rates too low as the cause of all of our problems.
Now the answer to our problems is to lower the rates again?
Does this not seem a bit contradictory. Maybe even purely illogical?
Posted by: Ralph | Sep 4, 2007 7:27:39 PM
and one more point you all missed
Lowered Rates will help the richest get richer. Thats a bit of a stretch - more like the folks with piles of chips can trade them for real stuff. Possession is 9/10ths of the law.
Posted by: Greg0658 | Sep 4, 2007 7:47:12 PM
Question: if the market is baking in a rate cut what happens when the expected rate cut never materializes? Now, what would you do if you were a voting member of the OMC? My guess is that they need to start talking this thing down some and not let the Bulls get full of too much bull-shit.
Posted by: Justin | Sep 4, 2007 7:49:57 PM
Folks,
The greatest bull market of the century is about to be launched. Do not miss this once in your lifetime opportunity to make crazy money.
We have all three components for it:
1. Negative sentiment, so negative that it seems as if the world is about to end (hence the books like Financial Armageddon and capitulation two weeks ago); bearishness not seen since 9-11.
2. The Fed begins easing (even Kass agrees that the Fed will cut)...
3. Martin Zweig's bullish momentum thrust (aka volume thrust)
Similar scenarios marked the start of the last century great bull markets.
Posted by: Rate Cut Nazi: “No Rate Cuts For You!” | Sep 4, 2007 7:50:49 PM
This, from FT.com, seems pertinent:
"However, the tools that modern central banks possess to address liquidity problems can only directly address such runs inside the traditional banking sector....
....central banks, which cannot channel funds directly to the non-bank financial sector...
....the institutions most affected at the moment are conduits and investment vehicles raising funds in the commercial bond market, rather than regulated banks.
'Most of the conduits are owned by the banks,' he said. In many cases, sponsoring banks are being forced to take risky assets back onto their balance sheets, in turn causing banks to keep hold of their own cash, putting pressure on short-term money markets, he argued.
Paul McCulley, managing director of Pimco, said there was a 'run on the shadow banking system'. He said the shadow banking system held $1,300bn of assets that now had to be put back onto the balance sheets of the banks.
The issue, he said, is 'how it is done and at what price.'"
This is the classic setup for a credit squeeze - it is the nightmare that wakes Bernanke in the night with sweat dripping from his chin.
A credit squeeze and central banks cannot directly address the problem.
Posted by: Winston Munn | Sep 4, 2007 7:57:19 PM
"6. Because we all know that the best way to cure a hangover is to drink another beer."
The Fed will cut rates and that's that..... They are going to act like a co-dependent enabler..... They don't need five, ten or one hundred reasons to cut. They are going to do it because they have been told in a few words that they must do "something significant" and they are not going to raise the rate. The question is will it be meaningful to the market. The answer to that question is no. Cutting rates does not bolster the creditworthiness of the borrowers, nor does it redefine the value of the underlying collateral.
A rate cut is a done deal on Sept. 18th the question is by how much.. 25bp is a non-event, 50bp is cautious, 75bp is $900 gold, 100bp is pay for dinner tab before you eat it to save a couple of hundred bucks, especially if you're having dinner at the Bristol in Paris, you may want to pay in advance for your suite's entire stay as well.
There are clearly some asset contigency issues involved here that could trigger a meltdown, that would make 1929 look like a cake walk.
I say, they cut at least 75bp out the gate. I also say that Putin will put the squeeze on the $ BIG TIME. Then and only then, we will see who the "coalition of the willing" really is. If anyone on this post really thinks that the Chi or the Saud is our friend, think again.
Just ask yourself this question.... Who would I lend money to..?
A CRACK HEAD...?
Harsh and Cold, that's the way I like it. ;-)
Econolicious
Posted by: ECONOMISTA NON GRATA | Sep 4, 2007 8:00:51 PM
One day a rate cut wont help us at all. How far are we from that?
Posted by: Owner Earnings | Sep 4, 2007 8:07:05 PM
Larry Kudlow is concerned for the economy and Barry Ritholtz says inflation is below 2%. I like this parallel universe better than the real one. Can I stay? The one I came from had wage stagnation, permabulls on TV and overvalued asset prices.
~~~
BR: Thats not me -- the indent, the different colors, the quotes -- thats another source.
Posted by: Rob Dawg | Sep 4, 2007 8:27:07 PM
A 20% haircut in some bubble areas is nothing.
It will take several years, if I remember the barbershops in RE in the 90's, to get the haircut half done.
Lots of real estate agents will be flipping burgers.
The fed, in any event, will tax Joe Six Pack with the inflation tax.
Many years ago Greenspan said the nanny state would use the inflation tax and he was being truthful.
This fed will save the wall street nanny state with the declining value of the dollar.
Posted by: ilsm | Sep 4, 2007 8:32:18 PM
QUESTION: Anyone able to help me understand why so much "mortgage backed" collateral was offered, but very little accepted? What causes the collateral not to be accepted?
Thanks!
http://www.newyorkfed.org/markets/omo/dmm/temp.cfm
Posted by: Robert | Sep 4, 2007 8:52:03 PM
Inflation is not the enemy. Leverage in credit markets is. The prime brokers spoon fed the crack addicts (hedge funds) an all you can eat margin party. The good news is that they puked out $ trillons...and many are dead. There will be one more pukeage, and many permafradycats hear will be too negative to take advantage of the last buying opportunity of the next few years.
That's ok by moi.
All in all, it's just another - BRICK IN THE WALL!!
Posted by: Frankie | Sep 4, 2007 9:14:38 PM
Frankie, very eloquent. I'm all for a little more pukeage.
Posted by: sweeny texas | Sep 4, 2007 9:28:11 PM
