Fed Cuts Rate by 25 Basis Points Again

Yesterday at the customary time of 2:15 Eastern, the Federal Reserve announced it was cutting the Fed Funds rate by 25 basis points (that’s 0.25%) and the discount rate by a similar margin. Then, things got a bit silly and violated what the text books all said should happen. Stocks fell, and the dollar rallied. This is what happens when the Fed doesn’t meet market expectations.

The market had thought that the 25 basis points on the Fed funds and discount rate was the bare minimum. However, there is no law that says the two rates have to move in tandem. Since the subprime mortgage problem is hitting the banks that lend, a discount rate cut of 50 bp was certainly credible. And there was a minority who thought that a 50 bp rate cut on both rates was feasible if only because it would allow the Fed to retain some mystery and doubt as to the next move.

In the event, though, the Fed did the least it could. It has also guaranteed Wall Street another one way bet at the next FOMC meeting. Rates are going to go down then, and they will go down 25 basis points because the Bernanke Fed can’t see another way to do things. However, there are some short positions that need to get liquidated first before the year ends, so hold on.

Meanwhile, the rate cut may actually result in higher oil prices. Stephen Schork, who puts out a newsletter called “The Schork Report,” explained, “The Fed rate cut is likely to increase speculation in the oil market; it's making money cheap. The oil market is in a prolonged bull run so this is not a bearish driver and it will help the case of the bulls who have been buying the market all year long. We had a massive correction in oil from $98 to $88 [per barrel] and for the past week the market has been finding consistent support at key technical areas. And now we have a major push going forward. If the market can't break $88, might as well go back to $98; the fed rate cut may be the catalyst the bulls have been looking for to get back up to the doorsteps of $100.”

So, what is guiding Fed policy? John Lonski, Chief Economist at Moody’s Investors Service and one of the finest practical economists in the business, said, “By cutting by only 25 basis points, the Fed effectively conveys its sense that recession risks are not as great as what market participants believe. In other words, the Fed sees recession risk as being less than 40 percent whereas the market sees recession risk as at least 40 percent. Again, the shallowness of the rate cut is somewhat surprising given that the economic outlook has worsened since October 31 and there has been a noteworthy widening of spreads since the 31st of October. All of this is to suggest that the Fed is fairly confident that what lays ahead for the US economy is nothing worse that a rough patch.” One hopes so.

© Copyright 2007 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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