Inches from Panic

23 January 2008



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Fed Slashes US Interest Rates

Yesterday, the US Federal Reserve surprised just about everyone with an announcement of a 0.75% cut in US interest rates. Markets in Asia and Europe had just had two terrible days of trading, and the Fed worried that the contagion would spread when the US market opened after a three-day week-end. The cut was the biggest since 1990, and it had the desired effect. The Dow Jones opened, plummeted almost 450 points and recovered 300 of those points. The trouble is that this won’t really fix things.

The Asian markets fell because they had risen way too fast in recent months. The US subprime mortgage mess was merely the excuse that the markets in Hong Kong and other go-go places needed to turn the other way. That’s how markets work sometimes. And when they drop, they tend to drag other markets along if they fall fast enough. That is what happened on Monday and Tuesday in Asia. Today, they’re recovering, in part due to the Fed’s action, and in part due to bargain-hunting.

The Fed’s rate cut will have an effect on US economic activity, probably late this summer or early in the autumn. Until then, the difficulty isn’t so much that interest rates are preventing borrowers from taking out a loan but rather the lenders are so afraid of not getting paid back that they aren’t lending at all. Until some of the banks get a better handle on just how much money is going to be lost in this fiasco, they probably won’t lend at any price.

In the Fed’s statement yesterday, it said, “Broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.” A rate cut doesn’t fix these, but it does show the Fed is concerned. Markets that are panicked need to be calmed somehow, and that was the purpose of the huge cut.

At next week’s Fed Open Market Committee meeting, the markets had expected a half a point cut. Now, it is anyone’s guess as to what the Fed will do. And that is a good thing because markets have been pricing in lower rates, making a one-way bet. Now, that luxury is gone and some real analysis is going to have to happen when research departments look at things. The US won’t have a recession (two quarters of negative growth, rather than “a significant decline in economic activity spread across the economy, lasting more than a few months,” according the National Bureau of Economic Research), but it is going to be much worse before it gets any better.

© Copyright 2008 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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