Will the interest rate cut be seen as prescient salvation or impulsive band-aid in the coming months? The Fed, it seems, were swayed by Frederic Mishkin who, notes The Economist,
argued forcefully in a recent speech that central bankers can cushion the impact of falling house prices on the economy, provided they act quickly and decisively, at little cost in terms of inflation.
While the markets bounced quickly it is not certain to be sustained and much can happen in the coming months. Let’s hope for stability, though our track record is not good and I can’t help remembering that Enron hired The Smartest Guys in The Room. We shall watch markets and data in the coming weeks to see where the pressure bears (ha ha).
As always, screening should be selective. Prefer fundamentals to story.
Further reading: An essay by The Economist discussing the Fed’s policy approach.
The European Central Bank left interest rates unchanged at 4% on 7 September, but it is not clear that they will not be increased to 4.25% soon.
The ECB is reacting to the increase in perceived risk in financial markets, catalysed by the sub-prime meltdown. At the same time as the hold on rates increase, the ECB provided another €42 billion to the banking system, whose liquidity has dried up as banks continue to be reluctant to lend to each other, without knowing the scale of losses in the lending markets.
Unfortunately, it will be some months before the scale and scope of the liquidity crisis might be known, and this will make interest rate decisions more difficult. However, I think it unlikely that they will be brought down this year.
Oh dear …
Well, it wasn’t as if it wasn’t expected. Futures were pricing a 100% chance of a drop of 0.25% and a 50% chance of a drop of 0.5%. But I still think it was a dangerous mistake. Inflation is pulling at the rein and the speculative dynamic of stock markets continues to undermine fiduciary responsibility and sensible personal wealth management. (For more on these concerns, please see August GRI Equity Review here.)
The first sign that the rate cut wasn’t appropriate was the bounce in the stock markets. After the decision was announced all three major US indexes were up more than 1%.. The Dow Jones industrial average was up 1.37% at 13,587.54, the S&P 500 Index was up 1.87% at 1,504.29, and the Nasdaq was up 1.60% at 2,622.95. As of this writing markets are still open, and up.
There will be a speculative rush for a few weeks until the reality that interest rates are not the problem sinks in. Perhaps on a positive note, they could be increased again if inflation accelerates too soon.
The most unnerving conclusion, however, is that the Fed is not able to give the tough love the markets need, or, even worse, emotions and personal interests got in the way of the decision.
The lower rate will encourage another bout of gorging on debt and further extension of an unsustainable mountain of credit. Consumer behaviour needs encouragement to change, to become more practical. The sooner the better.
(And here’s another discussion of the Fed’s Irresponsible Move published in BusinessWeek.)