Smart Borrower Blog

Fed Cuts Rates One Half Percent

Sep 21st, 2007 @ 6:45 AM by Alden Smith

In a move to bolster the economy, the Fed dropped both the federal funds rate and the discount rate by a half percentage point to 4.75 percent on Tuesday. Seen as a good move by the markets, only time can give us a good picture whether or not it is working. The Fed in its statement said that “some inflation risks remain,” but by making the more than expected half-point cut in its federal funds rate, the Fed is signaling that it clearly believes the threat of a recession outweighed concerns about inflation.

Some Concern

Allan Meltzer, author of a history of the Federal Reserve, called the decision a “big error”. The central bankers, he argued, had “listened to the Siren song” of the markets. History suggested they would regret it. Many feel that this is a bailout for Wall Street, and in the process compromised its inflation-fighting credentials. Ben Bernanke, Fed Chairman, is surely not following in Alan Greenspan’s footsteps.

The Risk of Inflation

Inflation is always a risk. Certainly, the Fed is hardly in danger of allowing price pressures to get out of control. Figures released on September 19th showed that core consumer prices, excluding food and fuel, rose by 2.1% in the year to August, down from 2.2% in the year to July. On the same hand, the dollar has hit an all time low against the Euro, and it was reported on NBC Nightly News with Brian Williams that the dollar is now equal to the Canadian dollar in value – the first time in 30 years. The bond market is not happy, either. They feel that this high of a rate cut is bad for the bond market. Indeed, prices dropped. Tuesday, the 10-year Treasury note closed down 14/32 at 101. The 30-year bond finished down 1 7/32 at 102. The 2-year note also fell 1/32 to 100. The bond market clearly sends the Fed a message – “Thanks for nothing!”

What We See

This cut may make a difference in the Wall Street fiasco. Surely, it can’t hurt. The other side of the coin is drops in unemployment, the all time high on the price of a barrel of oil and the profit taking from the Fed cut. None of these things can surely bolster the economy. It might do companies like Bears and Stearns some good, who posted wider-than-expected declines in quarterly profit yesterday. It also shows, however, that the market is shaky, with declining issues outnumbering advancers by about 8-to-3 on the New York Stock Exchange, on volume of 1.27 billion shares. Are these good signs of a stable economy?

It is predicted that it will take at least 2 years for the Fed cut to show signs of progress, either positive or negative. Much can happen in that time frame. Unless the Fed does something about sub-prime rate practices, and helps homeowners who are struggling to find a solution, it appears that the economy is in for a struggle…

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