Wednesday, September 19, 2007

What the Fed Funds Cut Means for the Future

Everyone was all excited about yesterday’s cut in the Fed Funds rate by 50 bps. Everyone acted as if good times were back again and here to stay. What concerned me most is what the Fed said and did not say about the rate cut. From the WSJ:

Federal Reserve Chairman Ben Bernanke moved aggressively to stop the spreading credit crunch from sinking the nation's economy with a surprising half-percentage-point cut in interest rates, casting aside for now worries about appearing to bail out investors.

The cut, which exceeded the quarter-point reduction most economists had expected, signals that Mr. Bernanke, fearing broad damage from the market turmoil that erupted a month ago, preferred to risk doing too much rather than too little. The move came amid a sizable drop in home sales, construction and prices that could send mortgage defaults higher and damp consumer spending.

In a break from the past, the Fed did not say whether higher inflation or weaker growth was its greatest worry or whether those worries were equal; it thus gave no hint about what its next move would be. "Some inflation risks remain," it said. But "developments in financial markets...have increased the uncertainty surrounding the economic outlook." (my emphasis) Markets put high odds on a quarter-point cut at the Fed's next meeting, on Oct. 30. . . .

. . . . "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," the Fed said in a statement accompanying yesterday's decision. "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." Sounds to me like someone is worried about the the effect of the credit markets on the overall economy. Not good news.

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