January 30, 2008

JustQuotes: The Federal Reserve Cuts Rates Yet Again (0.5%)

"The Federal Reserve lowered its benchmark interest rate by half a point to 3 percent, the second cut in nine days, and indicated its willingness to do so again to prevent a U.S. recession.

'Downside risks to growth remain,' the Federal Open Market Committee said in a statement after meeting today in Washington. In a reference to the volatility of the past five months, the Fed added that 'financial markets remain under considerable stress and credit has tightened further for some businesses and households.'

The dollar tumbled and two-year Treasury notes rose after the decision as traders anticipated another reduction at the Fed's March meeting, if not before. The cumulative reduction in rates since Jan. 22 is the fastest easing of monetary policy since 1990. The Standard & Poor's 500 Index closed 0.5 percent lower and is down 7.7 percent this year."

Fed Cuts Interest Rate to 3% as U.S. Growth Falters [Bloomberg]

First Published: January 30, 2008 3:22 PM

Comments from "Plugged In" Readers

Fixed rate mortgages are up on this news, curiously. Followed 10-yr treasury note rates up. I don't pretend to know enough about interest rate moves to explain this correlation (if any). Sell-off in the bond market?

Posted by: Trip at January 30, 2008 4:06 PM

The Fed should save the government a lot of money and just photocopy the Japanese announcements of years ago, change the date, and post them on the Fed Website. Including when they cut to zero.

Then, the press could copy the Japanese Property value charts from years ago, change the dates, and post them as US property values.

Posted by: tipster at January 30, 2008 4:13 PM

The Fed is trying to engineer a steep yield curve, just as they did prior to 1994. They do this to allow the banks to try to recapitalize themselves from the massive losses that are coming (prior to 1994, it was fallout from the S&L crisis). I'm betting that they will fail.

The timing of the Fed cut last week was foolish, and demonstrated to the world what those of us who understand what is going on knew all along: the Fed is terrified of uncontrolled asset deflation. To cut in the face of stock market declines - and ONLY because of stock market declines - is like waving a red flag to a bull, or in this case (to mix some metaphors) to a bear. Look for massive speculative attacks on US equities in coming months from the hedge funds with dry powder. I lived through these attacks on smaller countries during the 1990s (took part in many of them, I'm proud to say, in my own small way). Now that the hedge funds have grown by orders of magnitude since then ($4-5 billion of assets under management back then was a HUGE amount - today, it's literally 1 year's PAY for a SINGLE hedge fund manager: John Paulson, e.g.), I can tell you that they have been itching to go up against the Fed. It should be quite a show from here on!!

Posted by: Satchel at January 30, 2008 4:37 PM

The rate cuts might not be helping the fixed rate mortgages much but they are having an effect on the ARMs and HELOCs.

Subprime resets are obviously still going to be a problem but these lower rates could keep a lot of the Alt-A ARMs that are due to reset this year from going up drastically. Some Alt-A borrowers will still walk away due to the decline in the value of their house but for those that have some attachment to their home they won't be hit by such a huge jump in their mortgage payment due to a reset.

Posted by: Rillion at January 30, 2008 4:46 PM

as others have said... now the "smart" money will simply play the Fed and the volatility. I wish I was more brave and had more time to sit in front of a computer terminal. I wish I was "smart" money!

Ben fooled me once (way back last summer... when he first betrayed us with the 50bps cut). but I learned... This guy will drop as fast as he can as low as he can. And take our life savings with him if we let him.

I will only play a little... Gold like everybody else (for me since 2005). I cashed out all my longs today. Now I'll ride back and forth shorting then going long. (actually I use index ETFs and ultrashort ETFs instead of really shorting)

ride the market up... sell and go short... ride the market down, sell and go long... ride the market up... sell and go short... ride the market down... rinse, lather, repeat

this isn't good for the economy at all. but it will bring in bigger bonuses for Wall Street... the desired effect.

the sheeple will be happy because their house price won't fall as fast. But they won't realize that their entire net worth just dropped since the dollar is worth less and less and less every day. Hooray for $5 gas and $1000 gold. And 0% savings accounts.

Nominal house prices will do ok. Inflation adjusted they'll look horrible.

Posted by: ex SF-er at January 30, 2008 5:16 PM

Question for satchel/tipster/others:

Think there's a chance that, if rate cuts aren't enough, they start fiddling with reserve requirements to create liquidity and encourage banks to lend? It's a lever they rarely pull, but would make high inflation more likely if they used it (money multiplier). It would also be unprecedented for Fed Funds to go below 1.0%, so they only have 4 arrows left in the quiver assuming 50 bps increments.

Posted by: Dude at January 30, 2008 5:20 PM

Maybe the Fed should not have raised the short term rates so damn high in the first place, only to now freak out and cut rates after the damage has been done. Kinda Shady if you asked me.

Posted by: 123 at January 30, 2008 5:55 PM

Dude,

There is a very good chance that they will tinker with reserve requirements - I would argue that they already have. The TAF facililty is a way for banks to pledge bad assets against below market interest rate "loans" from the Fed. The latest data show that banks are NEGATIVE in the aggregate for their nonborrowed reserves, meaning they are out of money. This has NEVER happened before. Whether the banks are truly scraping their nickels together to meet capital adequacy tests imposed by their accountants, or whether they are simply taking advantage of the "free" money the Fed is offering, remains to be seen. I'm guessing it's the former. Things are REALLY bad for the US banks, and they are most certainly insolvent on a balance sheet basis.

I don't think you have to worry too much about high inflation, though. The problem is too much debt. Way too much. It can never be repaid, and so it must be destroyed (at least in part). Aggregate price level in an economy is correlated with money/credit supply. Only we "armchair economists" understand this. The academics are fools for the most part (and I am saying this as someone who holds an advanced degree from one of the Bay Area's "premier" research universities - and there are only two).

As money/credit supply deflates, aggregate prices go down. The only way to get some "inflation" going (price inflation) is cost-push inflation through a lower dollar. But this just leaves less money available to support asset prices, and pay wages out of corporate profits, for instance. Not good.

The only other way to get inflation going is through monetization. Ultimately, I am guessing the Fed will resort to this on a limited basis. However, in an economy that is at greater than 350% debt/GDP, and does not have domestic savings sufficient to fund the gap that would arise if foreigners were to abandon the dollar, printing is almost inconceivable. This is a very different environment from the late 1960s through late-1970s. As I have said many times, Japan is likely the playbook. No amount of "liquidity" can reflate asset values. That's just the way it is with credit deflations. They are nasty things.

FWIW I am not terribly worried about the dollar. I actually think it will strengthen against most currencies, with the large exception of the Yen and perhaps the Yuan (although China's economy is a HUGE mess!!). As a credit bubble deflates, people scramble to repay debt where possible, leading to repatriation of offshore dollars as well as to a scarcity of the object (the currency). The whole monetary base is only $860 billion. Not a lot of real money to access when the SHTF!! If I am right, interest rates should stay low, and the USG will be able to try (through fiscal stimulus) to moderate the pain of asset deflation. Again, just as Japan did.

What ex-SF'er says about trading stocks makes sense to me (and I, too, lost a good chunk to Helicopter Ben's blades back in September, but have I made it back in spades since then!!). My only addition would be to maintain a short bias as you trade the wiggles. The chance of a wipeout is greater than a moonshot IMO. Also, I have been long gold all year, and added in the late summer/early fall. I try not to think of it as an inflation hedge, because it isn't (except over very long periods). I think the long bond is a MUCH better indication on inflation expectations, and watching that (along with the monetary base) should tell you everything that you need to know!

Posted by: Satchel at January 30, 2008 6:12 PM

Agree Satchel. I think the best that we can hope for is money printing to create job programs at whatever level the forex markets and FCBs will let us get away with. If they spend the money on infrastructure projects like renewable energy it might even be a net positive for the country.

The japanese strategy allowed markets to correct with very little suffering by your average japanese salaryman. There were no hoovervilles full of starving people living in cardboard boxes in Japan during their 18 years of deflation and why should there be? We have plenty of resources to feed, house and clothe everyone.

Posted by: diemos at January 30, 2008 6:45 PM

ride the market up... sell and go short... ride the market down, sell and go long... ride the market up... sell and go short... ride the market down... rinse, lather, repeat

ex-SFer, would love to know where I can get a crystal ball to time the market so easily!

Posted by: james at January 30, 2008 6:46 PM

ROFL.

James...
in times of great volatility you don't need a crystal ball. that's the beauty.

I'll give you a counter example.
In good economic times, the market TENDS to go up most days.

Thus, you can just put your money in an S&P index fund, and forget it. Each day the fund will gain more and more and more. If you believe/know that we are in times of economic expansion, it's a no-brainer. Not a crystal ball at all!

In times like these, we have high volatility. Thus, the market goes UP 1-5% then goes DOWN 1-5%. You don't have to know the overall trend... just that it's going to go up and down and up and down. you don't even have to know WHEN it's going up and down (if you do what I do, which is buy ETFs and buy "short ETF's" as opposed to shorting or buying options)

IN these times you just jump in and out and in and out again. You don't try to time the absolute peak and bottom.. it doesn't matter. You just wait for your predetermined spots to jump in and out.

As example: everyone and their grandma knew that the Fed would drop 50 bps today. It was a very poorly kept secret. We also know that the market tends to rally on those days. Thus, I was long last week. (I jumped in a little early)

Today, I had a predetermined sell point. Once it hit that today, I sold and went short (using a Proshares short ETF).

In Bear Markets, once the "pop" happens after a rate cut, there's usually a let-down drop 2 days later. I"m thinking the market will drop pretty far on Friday... for a few reasons: first because it's 2 days after rate cut... second because it's the jobs report... third, because people don't like having their $$$ in the market over the weekeend in bear markets. thus we'll get some zigzagging! once my short hits it's predetermined sell site, I'll sell. (regardless if it's Friday or Thursday or Monday). Even if the market moves "against" me for a time... I"m pretty sure that at SOME point the market will drop to my predetermined "sell" point... so I just wait (actually the computer will sell my position automatically!)

Also, the jobs report is this Friday. Sure to have volatility there as well.

The next time I'll make a big position is right before the next Fed meeting in March. I'll go long a few days before the meeting. Again, they'll drop the FFR as always (what a surprise), and we'll get a "pop". I will SELL my longs on that "pop" and buy a short-ETF

It's just nickel and diming the market... but with the right position you can make a fair amount.

again, you don't have to time, or to have a crystal ball.. you just have to know that we will have volatility. Then you sell when the market goes UP, and buy when the market goes DOWN.

The DOWN SIDE: if you are wrong and we don't have volatility. So as example, if we have a surge in the Russel in the next 2 days, then I'll lose some money...

or if I go long and we don't have a "pop" then I would lose as well...

don't get me wrong, 95% of my assets right now are into gold, and Treasurys i bought late last year. (locked in 5+% yields becasue I knew the Fed was gonng drop drop drop)

it's only 5% of my assets I'm "playing" with.

overall, Ben is killing me by dropping the value of the dollar (most of my assets are dollar denominated). but you do what you can.

Posted by: ex SF-er at January 30, 2008 7:21 PM

Reserve requirements were effectively gone by the late 1990s. That is part of the problem, along with the practice of repackaging loans which is not going away.

The exact timing of these rate cuts doesn't really amount to much. The house of cards was already coming down, so this is just to cushion the crunch just a little. The reactive day trade oriented view of the market has value, but the Fed but their reports and actions appear to be working with the idea that changes to rates have long term repercussions and are moving the bar based on that. Warning of these rate cuts came some time ago. No one needs to accept this kind of long term view for themselves, but to see the Fed as a moment by moment market player seems a distortion not supported by any public policy statements.

Posted by: Mole Man at January 30, 2008 7:58 PM

The fed can cut rates to 0% if they want but it won't change a thing. They have lost all credibility and control of their monetary policy.

Posted by: ali at January 30, 2008 8:11 PM

cool, I have a HELOC of 500k at prime minus 1%...anyone need a hard money loan ;)


Posted by: Dave at February 1, 2008 7:56 AM

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