Tuesday, January 22, 2008

Fed Panics as Interest Rates Slashed

After many years of cutting interest rates by 25 basis points at a time, the Fed responded to growing stock market uncertainty by cutting interest rates by 0.75%

It is quite a bold move, although whether economic data merit such a big cut is a matter of debate. It is certainly indicative of the changing mood sweeping the US economy. Although in 2007, there were concerns over the Housing Market it was hoped that the economy might avoid a serious recession. However, with no signs of a slowdown in house prices, and worsening company profits Wall St brokers have voted with their cash - selling shares as most now predict a recession in 2008.

What effect will a 0.75% cut in rates have in 2008?

The big question is to what extent the cut in interest rates will have an impact on the economy?
  • The immediate effect is that homeowners will see a fall in their mortgage payments. This will make a significant help in avoiding a growing number of mortgage defaults and house repossessions.
  • Liquidity Trap? It is argued by some that cuts in interest rates may be ineffective in increasing demand; this is because confidence is already low and lower rates will not stimulate investment and consumer spending. Although their is some truth in this I do feel that a 0.75% cut will be a big help to the housing market - one of the weakest areas of the US economy

More Problems for the Dollar.

One thing the Fed have made clear with this cut in interest rates is that they are not concerned with a falling dollar (or at least it is not their highest priority). This cut in interest rates will make dollar securities even more unattractive contributing to further falls in the dollar.


Amidst all the talk of recession, it seems rather impolite to bring up the topic of inflation. Yet, despite the doom mongers and predictions of recession, there are signs that inflation has not been completely subdued,
  1. rising commodity prices are pushing up costs.
  2. The dollar's devaluation is pushing up import prices.
This cut in interest rates will increase inflationary pressures at some stage. Although it is fair to argue that inflation is the least of America's problems at the moment.

A Reward for Bad Lending?

With all the problems over bad mortgage lending, such a big cut can be seen as throwing a lifeline to many subprime mortgage dealers. It may be harsh but this rate cut might be seen by some as 'rewarding' bad lending.

No comments: