Fed Cuts Federal Funds Rate to 4.75%

I am surprised. The Fed cut the federal funds rate more than I expected, from 5.25% to 4.75%. Here's the Press Release:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4 3/4 percent.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee's last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Charles L. Evans; William Poole; Eric S. Rosengren; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50 basis point decrease in the discount rate to 5 1/4 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, Cleveland, St. Louis, Minneapolis, Kansas City and San Francisco.

Comments

[anne]

Excellent; the Federal Reserve has been leading and is reacting to the bond market. We have, after all, a 4.53% rate of the 10 year year Treasury. Why not show the Fed as decisive?

[Bernardo Aito]

Hi all,

FED cuts half%. This makes for the argument that Bernanke may be willing to push down the Dollar even more in order , perhaps, to correct the external imbalance. Will now China want to sell Dollars? What will other investors do with their greenbacks?

interestingly, on my blog's poll ( http://www.thedailyeconomist.blogspot.com/ ) , only 12% forecasted such a cut. The bloggers didn't perform well this time, did they?

Best

Bernardo

[Macro Man]

Bernardo, I'm not sure if I am indicative, but I've sold dollars since the announcement. I suspect that I will have plenty of company in the next few weeks/motnhs.

[esb]

Macro Man ...

Sold dollars against what ... euros?

If you are not interested in using leverage greater than 2X then you are better served by using "FXE."

[anne]

Good grief; investors have been selling dollars for several years, but the Federal Reserve cycle could easily lead to a strengthening of the dollar. The point for the Fed is not the value of the dollar but stimulating growth. For investors, the question is also growth.

[Cassandra]

Anne said
"Why not show the Fed as decisive?"

It seemed as if they were finally attempting to be decisive by "holding the line" on rates after an extended period of negative real rates, asset inflation and stonkingly-large credit growth ... but that decisiveness lasted about all of a month. What are we to call it when such decisiveness is decisively undone???!?

I would suggest that since such decisive undoing of attempted decisiveness continues (as it has in recent memory) to be asymmetrically skewed in favor of pain-avoidance and ease, that it is yet another red-cape teasingly inflaming the risky-asset markets of the world. So...long commodities, long precious metals, another helping of impressionist art, short dollars, short bonds all around in heaping portions...dad will bail you out of jail!

[esb]

The central banks will attempt to hold the euro from penetrating 1.40. I suspect they will fail.

Also, there will most likely be substantial central bank selling of gold in a futile attempt to prevent a moonshot.

It is so easy to trade against the "one trick pony" US central bank, anyone capable of spelling "inflation" can prosper. (Actually, the only way TO prosper is to assume inflation, whether reported properly or not.)

The "tell" in this game is that the S&P500 is actually UP quarter to date. That's right, UP.

[RJH Adams]

Cassandra,

are you suggesting - and I can hardly believe you would - that Daddy's lost his new .45?

Or worse - that our Daddy's not our Daddy but our Daddy don't know?

R

[TigerPaw]

Isn't this rather like giving a drunk with a hangover a glass of vodka for breakfast to help him feel better?

[Macro Man]

Esb, I am, for my sins, a professional investor, so I use the interbank foreign exchange market. And yes, I bought euros, as the euro is the anti-dollar.

Given that central banks were observed buying EUR/USD well above 1.39 after the rate cut, I wouldn't expect much of an effort from that sector to prevent 1.40 from going. Sarkozy, yes. The world's biggest remaining dollar longs, no.

The unwillingness of the Fed to allow US financial assets to become sufficiently inexpensive to lure private sector buyers (another crappy TIC today) suggests that the exchange rate will need to bear the burden of rendering US assets cheap enough to entice the private sector.

For most of the last few years I have been willing to give the dollar the benefit of the doubt, but no longer. For the time being it looks like the US will join Japan in the world's financial junkheap, with a consequent trashing of their respective currencies.

[esb]

Cassandra ...

What you need to understand is that the political tolerance in the US for a recession of any magnitude whatsoever is now zero. This means that any recession will be prevented regardless of the consequences of the measures taken to effectuate the prevention.

Knowing this logically leads to what George Soros once identified as "one way trades." You have identified a few.

Or, to put it a little more humorously, "all rise."

[Cassandra]

RJH -
To extend the .45 analogy, I think "daddy" was playing with the loaded weapon, pulled the trigger, heard the "click!" but no "Bang!" and decided to have a look down the mouth of the barrel, pulled trigger and this time there was something in the chamber and he unwittingly just blew his face right off o' his head!

Now, without being to too disrespectful to our Anne, after today, dad will have to decisively undo the undoing that he's now decisiveely done, made all the harder because he's got powder burns all over his face, for he is now the laughing stock of the leveraged specs in risky assets who must feel like true masters of the universe just about now. Talk about the sap walking around with a "Shoot Me!" sign on his back....

[anne]

Gee; imagine why I am not the least worried, the Federal Reserve acted just as it should have acted to protect and stimulate growth in an absence of an inflation problem. Of course there is the tic and the toc, ticcing and toccing, but I always liked the sound of clocks.

[kthomas]

anne, I almost find your "tic toc" metaphor a little scary.

bombs also tic toc, and I know you don;t like those.

Sorry, but though the Fed is acting with something what MIGHT be called leadership, others would argue this decision is just perfume on a pig, and they would be right. tic toc.

[Winslow R.]

Mark wrote: "I am surprised."

Me too!

Bernanke no longer appears to be the academic technocrat he seemed to be.

I think, as Anne has stated, watching the long bond over the next few days will give an indication if the Fed has truly started targeting growth despite inflation or has found room to maneuver.

So far the long bond has been stable indicating that it does. Personally I think the Fed should keep cutting until long-term rates do start to move up. I see it as likely they could hit the zero bound with no effect :( Trying to 'push' long-term rates by raising short-term rates up has failed.

I'm inclined to believe this single move is insufficient to 'protect' the economy from the political process as it hardly targets where money is needed most. A fiscal bailout is likely still in the cards.

[Timetheos]

Bombs go tic-tic, not tic-toc

[Winslow R.]

Bernanke is in the delicate position of shredding just enough of his credibility to get savers to spend.

[esb]

Winslow R ...

Long rates are no longer capable of producing accurate economic signals. To a large extent they signal the essentially political decisions taken by the PRC and our other "bankers."

[evagrius]

The Canadian dollar is almost at parity with the U.S. dollar.

First time in many, many years.

[Cassandra]

WInslow said
Bernanke is in the delicate position of shredding just enough of his credibility to get savers to spend.

Indeed....who are "The Savers" in a nation of dissavers?? The savers are of course foreign official entities, and since their motivations "special" in the mercantile sense, I fail to see how the incremental change in rates will get them "to spend". But of course, I see the world NOT through the lens of a savings glut driving US consumption, but excess US consumption driving the so-called foreign official savings glut, financial Calvinist that I am.

[billy]

What a crock - the Fed acted like the hired lackey of the speculators they are. We can all expect the same Greenspan-esque cover-your-ass from BB when BB's memoirs come out.

This is just distributing the higher asset prices into the rest of the economy. The burden will spread from asset owners to the rest, and from larger asset owners to the smaller ones. People who speculated in assets are getting bailed out, and the cost will be on the others.

The net effect? Those who were the wealthy asset owners before the bubble, will still be at the top; the middle class nouveau rich will feel their wealth slowly eaten away, and those who tried to save and move up, will see their savings wiped out.

A better mechanism for creating a society of aristocrats and plutocrats with zero social mobility cannot be devised. Nothing else will create such an iron-clad guarantee that whatever you do, the fruits always goes to those at the top.

The nouveau rich are looking at their asset prices and parroting "the Federal Reserve acted just as it should have acted to protect and stimulate growth in an absence of an inflation problem."

Wait, till their "wealth" bleeds slowly in purchasing power, even when their asset prices in $ terms do not.

Go with Macro-man. No more dollar-denominated, sell into this rally.

[ilsm]

Right after the announcement the dollar dropped for a few minutes to 115.1, immediate sprang up to 115.7.

BoJ on its course.

China will do same.

So, do US exports to euro zone increase while the status quo ante is evident with the Pacific Rim?

Does not seem like any major effect on CAD.

Let the good times continue, the BoJ paying 116 yen for each dollar, all will be good.

Do I hear helicopters?

The BoJ will vacuum up any excess.

[save_the_rustbelt]

Is the Fed taking orders from Larry Kudlow and Jim Cramer?

Now that is scary!

[Winslow R.]

esb wrote: "To a large extent they signal the essentially political decisions taken by the PRC and our other "bankers.""

Exactly. This is where any credibility shredding will need to impact for those shorting the dollar to make a killing. So far there is little impact as Anne has stated. Macroman's portfolio is insufficient to move markets.

Time will tell.

[bubble-fan]

Thanks, Ben.
Next bubble, natural resources, all aboard!

[billy]

Is the Fed taking orders from Larry Kudlow and Jim Cramer?

They got BB house trained very quickly.

[calmo]

So if the Fed went for the 25bp, there would be a more subdued market response and likely less angst here.
But what if they dropped a further 25bp at/before the next meeting?
Is the chunky move now, a deliberate move to see if those long rates can be budged with one hard blow?
LIBOR has moved down somewhat from it's peak, but not much yet in response to this cut, no?

[wkc]

I agree with the original message that the 50bp cut is more than what i expected. In fact, the statement seems to have totally sideline inflation risk ahead - no mention of resource utilisation let alone the soaring oil prices ! All focus seem to be growth or rather potential downward of growth ahead.. Is there a "broad" view that the economy is doing good outside housing ? how high is the risk of spread ? and how would i gauge that risk? I dont think rate cut would be able to restore confidence.. and if so, it might send a wrong signals ....

[One Salient Oversight]

I wrote this before the rate cut

Why Bernanke shouldn't blink

Imagine this situation: You have a friend who spends money like it is going out of fashion. All he does is buy things or invests them in crazy schemes. But in order to fund his spendthrift ways he needs to borrow money from his family and from friends like you.

One day your friend comes up to you. He is in a parlous state. He has lost all his money on failed investments. He owes so much money that some of his belongings have been repossessed already.

You shake your head at his story but you can't help but feel as though your friend is entirely to blame for his situation. You knew the warning signs were there and you're miffed at the fact that the ten thousand dollars he owes you may never come back.

You also know what he should do. He should cut his spending and live more frugally. He should divert most if not all of his remaining income into paying off his debt. You know that this process will be hard for him, but before you can say anything he asks you: "So, are you going to lend me money to cover my costs? Come ON man!".

What would you do?

By the time you read this, Ben Bernanke may have publicly announced a cut in official interest rates. To me, this is the complete opposite of what should happen. If you haven't worked out my anecdote already, the spendthrift friend is the market, who is reeling from the Subprime meltdown. You, of course, represent the Federal Reserve bank.

I'm a great believer that economics is actually simpler than what most folks think. I believe that the anecdote I have shared is true both in its micro and macro form - the best way to make people treat their money properly is by treating it seriously. This is as true for the poverty-stricken underemployed worker in Michigan as it is for the Wall Street stockbrokers who command eight figure salaries.

To cut interest rates would, in this case, be the same as lending your spendthrift and near-bankrupt friend more money. The Subprime meltdown, which is likely to plunge America and much of the world into recession, is a result of market failure. Easy money and easy credit have distorted the market's ability to spend and invest wisely.

But the market is, of course, demanding that Bernanke cut rates. "Come ON man!" they are saying to him "we'll be ruined if you don't cough up!".

It seems to me that the market's argument is that the cause of the problem is its solution. If easy money and easy credit have caused the market to go haywire, then the solution is more easy money and more easy credit. To me, this makes as much sense as a heroin addict arguing that the best way for him to get off drugs is to have another hit of heroin.

But in the anecdote you have the chance to say to your friend "No! I am not going to help you in this. The best thing for you to do is stop spending like it is going out of style and to stop investing money in crazy things! You have to cut your spending and live frugally until you pay off your debts!".

If Bernanke and the Federal Reserve wish to act in the best interests of America and make the best decision then they will decide to, at the very least, keep rates where they are. This may not be popular, but it will be the right thing to do. The market needs to learn restraint and the best way to do it at the moment is through frugality and austerity.

Bernanke has two choices: He can be a Greenspan or he can be a Volcker. If he chooses to be another Alan Greenspan he will cut rates, bask in the glory of sharemarket highs and then, in his retirement, be reviled for being part of America's poverty. If he chooses to be a Paul Volcker he will, like Volcker did in 1980-81, refuse to blink as he acted for the good of America's economy. Volcker's actions were instrumental in bringing about a protracted recession, but were also responsible for bringing about sanity into the world economy for some years afterwards.

If Bernanke wants to be as courageous as Volcker then he will keep rates as they are or even raise them. By doing this he will, no doubt, help bring about a global downturn over the next 18 months... but at least he would have done the right thing and helped bring America's (and the world's) economy back into balance.

[dissent]

My take is that the Fed looked at the data & the overall picture and became very worried indeed. This is a radical gambit to forestall the serious deterioration which is already in progress. It should not be read as sop to Cramer and company, but as an indication from those that know that the waters are indeed deep and muddy and swirling very fast. Here's hoping we all are up to the swim.

That said: welcome to the dollar crash. I'm rather looking forward to it.

Finally, this move, among other things, reflects the triumph of national concerns over the globalization agenda. We'll see how that plays out given that we are so (woefully) interconnected.

[Bruce Wilder]

esb: ". . . the political tolerance in the US for a recession of any magnitude whatsoever is now zero. This means that any recession will be prevented regardless of the consequences . . ."

Exacto mundo.

BB is a reactionary inflationist, put in place to provide an inflation to benefit the plutocracy. This is the opening curtain on Act 1, Scene 2 of a drama, intended to continue for a decade or more, impoverishing the American People at least as much as the Reagan-Greenspan drama of the 1980's.

[Bruce Wilder]

esb: ". . . the political tolerance in the US for a recession of any magnitude whatsoever is now zero. This means that any recession will be prevented regardless of the consequences . . ."

Exacto mundo.

BB is a reactionary inflationist, put in place to provide an inflation to benefit the plutocracy. This is the opening curtain on Act 1, Scene 2 of a drama, intended to continue for a decade or more, impoverishing the American People at least as much as the Reagan-Greenspan drama of the 1980's.

[BJ Feng]

Looks like the Bernanke put is in place. The more Bernanke accommodates, the more the market and people will expect him to accommodate in the future. Without the fear of losses, speculators will not restrain themselves.

When is the FED going to drain the system of liquidity? They've been able to expand it at will because China and other emerging nations needed the extra dollars to hold as reserve. But inflation in China is increasing fast, 6%+ last time I checked, they're not going to be able to absorb any more of our inflation, and they don't need any more dollars. Bernanke should understand that he can't continue the easy money policy of the past without great risk of inflation.

The incompetent Bank of Japan is even worse than the FED at being bullied around. How long have they wanted to raise rates a puny 0.25% now? They have to understand that their low rates are being used to finance speculation around the world and are having little effect in Japan itself. Furthermore, when the speculation ends, it'll end all at once with a flood. We saw a little bit of that when the Yen/dollar rate changed by more than 5% in a matter of hours earlier last month. The adjustment will come quickly, the longer they continue with their easy money, the larger the adjustment will be. They have to understand this, at least I hope.

[voltaire]

Ben (Bubble-Boy) Bernanke--or just BB for short. Has sent the signal we all thought he would when push came to shove in the markets. "I, by the grace of God,...will not let the US slip into a recession (let alone a depression)". On other hand what he is not saying, but 100% is implying, is that you better be dusting off your Weimar wheelbarrows--unless of course you protect yourself by owing that barbaric metal. Let's see what is it an ounce...$730, seems like just yesterday our government was fixing the price at $35. Central banks always have and always will create a moral hazard cess pool of speculation and bailouts. I'm sure Jefferson and Jackson are spinning faster in their graves tonight wondering when another president will come along to kill the 3rd CB of the US--the Fed. Rome took 300 years to crumble I bet we do it in 150... say 2060.

[calmo]

Does the beige book contain any more details than were issued in this release?
This bitEconomic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time. mentions the housing correction and its (ok maybe not this explicit, but why should we go into denial just to save the Fed's face?) attendant effect on "economic growth more generally". Now we wait for those mortgages to come down half a percent and end the "housing correction"...before housing price deflation spills over into the "broader economy".
Was this the first dose of meds for a diagnosis of deflation in the economy? I find this paragraphReadings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. most unconvincing given the consumer based definition of inflation here and the consumer's drying disposable income.

[billy]

Was this the first dose of meds for a diagnosis of deflation in the economy? I find this paragraph..

Look at what's missing today, that was in 8/7. This ..

"However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures"

Has resource utilization fallen? More spare capacity?

Where's evidence of a moderation in inflation pressures? Is that wheat, oil, commodities going up?

Where are the so-called "effects on the broader economy that might otherwise arise from the disruptions in financial markets" ?

The bankers losing their bonus? The speculators seeing their windfalls gains disappear? The hedgies and IBs- whom Cramer calls "his people" - hurting?

[dd]

This isn't about growth; wish it were. The banking industry is in serious distress. Will the cut force money markets back into asset backed commercial paper market in search of higher yield in the same way Greenspan's cuts found MMF flooding into the market? Don't think so; the confidence is gone and a rate cut if anything may cause an even more conservative stance; but right now it's the only tool the Fed has and they've gotta prod the ponies out of the padlock.

[esb]

Mark Thoma ...

I know for a fact that the Fed operates a small "team" within the staff which collects what we would call "anecdotal information." Someone credible mentioned to me that the team refers to its work product as "the anecdotals." I have no idea whatsoever how it is collected or from whom.

I suspect that this large event today flows from the reactions in the meeting to something in the anecdotals ... some item or items of information not widely known or measured or understood but dangerous and perhaps even shocking.

So my question to you is, if you were the "decider" at this meeting, what type of undisseminated information could have prompted you to take this dramatic decision? Could you have taken this decision simply because you determined that you possessed no clear understanding of what was unfolding throughout the financial sphere?

[voltaire]

Mark,

Simple. BB is meeting with Barney on Thursday. Having Frank putting him on the spot during last meeting over the 'right of congress to debate (read... participate in setting) the FF rate' I'd say 'anecdotally' he got the message he better lower it.

Utilization both capital(82.2)and labor(4.6%)unchanged m/m, biege book, steady-as-she-goes, doesn't in any way call for a 50 basis pt. reduction, so anecdotal it must be. Let's call it the 'Barney Factor'.

P.S. We have also not heard a peep from BB on Inflation Targets after that meeting with Frank.

[gordon]

The discount rate was also cut, maintaining its new relativity of 50bp above the funds rate. I'm still wondering whether the Federal Reserve has given up on its discount window/repo strategy which was designed (as I understand it) to renew confidence in the commercial paper which is now accepted as collateral at the discount window. What are the consequences of this strategy failing (ie. commercial paper remaining effectively "devalued")?

[donna]

Meet the new boss....

Same as the old boss ....

[ScentOfViolets]

I see a lot of argument about the motivations, but not a lot of discussion about what future event, or set of events, would distinguish between the two. Absent the one-shot case of massive bailouts just before the end when just retribution can longer fall upon the wicked, of course.

Hmmm . . . maybe that's the ploy. Deliberately keep things muddy so people can't honestly distinguish between the two. If that's the case, whatever happens next will also have a similarly ambiguous intepretation as to motivation. And if that's true . . .

[jan perlwitz]

I think the whole fuss and excitement is mainly about nothing. Whether the Fed funds rate is 5.25%, 5%, or 4.75% it won't have any substantial effect on future inflation or economic growth. The Fed decision is way overrated, here and elsewhere.

The Fed funds rate is the interest rate for which banks lend each other excess reserves of their Fed funds to meet their reserve requirements. The daily amount of this lending is about $2 billion US-dollar only, which is a minuscule amount compared to the credit markets with a size of many trillion US-dollars in an economy with a $13.8 trillion US-dollar GDP. It's not plausible that the interest rate for the lending between bank from a money pool of a size of about $2 billion US-dollar has a significant effect on future inflation, economic growth, or the business cycle. What is the causal relationship supposed to be that would establish this alleged effect, in which obviously almost everyone believes, whether they are pro or con the Fed decision?

People, you are all excited about the tail who tries to wag the dog! Why?

There is no one in charge who can control capitalist economy and its markets just by tuning some little parameter. Maybe you all are controlled by wishful thinking, though, that there were someone who can?

There are other factors in economy that really affect inflation and economic growth. For instance, when the government spends trillions of US-dollars on armament and waging war, it will probably have a substantial inflationary effect, since from an economic point of view, these are wasted resources. These are resources which are being destroyed, instead of being productively consumed.

Please could someone distribute some sanity in the world.