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F. T. : Rate Cuts Are Unlikely To Stop Global Hangover

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Rate cuts are unlikely to stop global hangover

By Michael Mackenzie in New York
Published: March 1 2008 02:00 | Last updated: March 1 2008 02:00
The Federal Reserve is attempting to fill up the liquidity punchbowl with big interest rate cuts. But it is beginning to look like an old party trick. Cheap cash for consumers and Wall Street banks has not translated into lower mortgage rates, let alone alleviated stress in the credit market.
Instead the prime beneficiary has been commodities. The dollar has fallen out of favour and set record lows against the euro and a basket of rivals, helping to boost commodities prices across the board.
Since the Fed started to cut rates last September, the Reuters/Jefferies commodity price index has risen more than 30 per cent, with oil, precious metals and wheat all setting record prices this week.
As a result, the beleaguered US consumer faces a creeping tax in the form of higher petrol and food prices, on top of negative wealth effects from housing and the stock market's slide since October. If this trend continues, consumers may get little relief from rebate cheques due in the summer as part of the government's fiscal stimulus plan.
The real sting, however, from higher commodity prices and a weaker dollar comes in the form of higher inflation expectations. In the past month the yield on long-dated Treasury bond yields has risen sharply and the deteriorating mortgage market has pushed home loan rates back to where they were last September.
In other words, the 2.25 percentage point cut in the Fed funds rate in this period has not sparked the kind of mortgage refinancing boom that slashed home loan costs for consumers earlier this decade.
When the Fed sharply lowered interest rates between 2001 and 2003, problems caused by the technology bust were alleviated as easy money pumped up the value of real estate and ultimately fuelled a bubble in credit.
Now, a year after subprime mortgages emerged as toxic waste in many investment portfolios, banks and homeowners share a problem. Both need to shore up reserves of cash - whether through capital or savings rates - as many areas of the financial market remain dysfunctional and home prices keep falling.
No surprise then that Ben Bernanke, Fed chairman, told members of Congress this week that in spite of "some similarities" with 2001, "both fiscal and monetary policy" faced additional constraints.
"The effects of the stock market decline in 2001 were primarily on investment firms and not on consumers," Mr Bernanke said. "Now consumers are taking the brunt."
Higher commodity prices were also causing "inflationary stress" and complicating the Fed's efforts in countering the slide in the economy.
That will not stop the Fed cutting rates further, because an easier monetary policy is the central bank's major tool. Its hope is that helping the banking system via a steeper yield curve - which should make lending for the long term more profitable - will eventually resurrect the credit system. But such a process takes time.
The edge of rate cuts is clearly blunter now that the links in the global economy are more pronounced than they were earlier this decade. More rate cuts weigh on the dollar. They also sharpen the appeal of owning commodities that are a bet on faster growth outside the US and a hedge against inflation
This week the California Public Employees' Retirement System, the largest US pension fund, announced it would put more of its money into commodities, illustrating that they are increasingly seen as a viable asset class by investors.
As the funds rate falls, it is no surprise that money is flowing into commodities and not equities, or for that matter arcane parts of the fixed income market, which are still being shunned.
Meanwhile, the prospect of a hard landing for the US economy grows as the commodity boom blows back on the consumer with higher prices for essential goods.
Therein lies a harsh reality for the Fed. An extended slowdown or recession in the US will eventually sap global growth as US consumers rebuild their savings and in so doing place a floor under the dollar, break the commodity boom and arrest rising inflation
This time it appears a hangover cannot be avoided by simply refilling the punchbowl.

Been saying this for a long time now. Credit is the issue, not IR. Ben might as well stick with a rate to keep slightly ahead of inflation, say 5%, and avoid the panic ridden cutting frenzy that is doing more harm globally than good. Just let the houses crash is the best the CBs can do. Don't resist the force Ben--go with it.

Edited by Realistbear

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When is the next Fed meeting, anybody know? The last one was Jan 30th.

They don't need to have meetings to cut rates nowadays; a round-robin email is adequate quorum, apparently.....

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I Do Expect Some Banks to Go Under,

And So Do the Banking Regulators!

Heck, we're already seeing the number of "problem institutions" flagged by the FDIC rise. It climbed to 76 in the fourth quarter of 2007 from 65 a quarter earlier and just 50 at the end of 2006. Problem banks are those with "financial, operational, or managerial weaknesses that threaten their continued financial viability," in the words of the FDIC.

Regulators can see the writing on the wall. So I also wasn't surprised to see the Wall Street Journal run a story this week headlined "FDIC to Add Staff as Bank Failures Loom." It said:

"The Federal Deposit Insurance Corp. is taking steps to brace for an increase in failed financial institutions as the nation's housing and credit markets continue to worsen.

"The FDIC is looking to bring back 25 retirees from its division of resolutions and receiverships. Many of these agency veterans likely worked for the FDIC during the late 1980s and early 1990s, when more than 1,000 financial institutions failed amid the savings-and-loan crisis.

"FDIC spokesman Andrew Gray said the agency was looking to bulk up 'for preparedness purposes.' The division now has 223 employees, mostly based in Dallas.

"The agency, which insures accounts at more than 8,000 financial institutions, is also seeking to hire an outside firm that would help manage mortgages and other assets at insolvent banks, according to a newspaper advertisement."

Bottom line: When it comes to the financial sector, I'll repeat what I've been telling you for months:

Bargain hunting in the housing and financial stocks still looks like a high-risk, suckers' game to me!

There is NO evidence I can see that a definitive "bottom" for housing is in. The magnitude of the credit challenges facing the financial industry is enormous. And the potential for outright bank failures to roil market confidence in the coming months is high.

So I think you're better off staying away, keeping your money safe, and taking advantage of the massive profit opportunities elsewhere

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  • 296 Brexit, House prices and Summer 2020

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