The market has risen about 400 points since Ben Bernanke cut the Fed Funds rate by 1/2%, but that's not what bugs me. Who doesn't like it when their investments are worth more one day than they were the previous day?
And it's not that I don't think the rate should be decreased. I think it was a mistake that short-term rates were increased to 5% at the start of 2006. We had a dozen consecutive increases raising rates from just over 1% to nearly 5%, and it would have made sense to me to wait a few months to see what impact rates above 4.5% were going to have on the economy. Instead, we kept raising rates and it's no surprise that today we're wringing our hands wondering if he didn't go too far.
A 4.5% Fed Funds rate, plus or minus 25 basis points, is probably where rates ought to be. I'm not disappointed that the short-end of the curve came down.
What disappoints me is that the Fed has been on this anti-inflation campaign and William Poole, the Chairman of the Fed Bank of St. Louis, said in mid-August that, "No one has called up and said the sky is falling." He intimated that it would take some sort of calamity to get the inflation hawks to change course.
Two days later, the Fed cut the discount rate and this week the Fed Funds rate came down. What do they know that we don't know?
We already know, for example, that loan defaults have recently doubled. We know that residential building permits fell to below 1 million starts, the lowest level since June of 1995. In fact, the August number was the worst non-Winter report since April of 1990, during the nadir of the Savings & Loan debacle. We already know that retail sales growth is anemic, and that Wall Street's money machine is having trouble selling the big LBO buyout loans to which it committed over the Summer. But what don't we know yet? (One thing we don't know is what is the "clearing price" for those junk bonds that need to be issued, which will determine just how big of write-offs will Wall Street banks be taking at year-end.)
We already know that the Fed's announcement caused gold and oil prices to soar as global economic players discount, yet again, the value of a dollar. Travel overseas, lately? It used to be that New York was the expensive part of the trip. Now it's "over there" that you can't afford to shop. But we already know that. We know that we're increasingly dependent on overseas investors funding our deficits, and this week's 10-year Treasury auction was practically boycotted by foreign investors. But we already know that. What, besides "what is the clearing price of a U.S. Treasury Bond if foreign investors don't participate in our auctions," what don't we know?
Something that we don't know yet, but the Fed does, has them scared enough to turn policy on a dime and turn almost overnight from policy hawks into rate cutters.
The reason I'm disappointed is that I've been saying for awhile that we're headed into a recession in 2007, and it looks like the Fed has finally come around to my views.
Last time around, the first Fed cuts came in the Spring of 2001. The party didn't last too long. 2001 and 2002 were awful years for stock investors. The market's aren't as overpriced as they were then, so we don't have as far to fall, but things don't look too good out there. If you don't believe me, just ask Ben Bernanke.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
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