Yesterday, FOMC Chair Ben Bernanke cut the Fed Funds Rate (and the Discount Rate) by 50 bps (0.50%). While the market was pricing in a roughly 50/50 chance for either a 25 or 50 bps discount, I think experts and econmists put the odds more between the 25 bps cut and no cut at all. I cannot say that he surprised me by doing so, considering the markets predictions, but I do think he made a poor decision.
I am not an economist, so I will not claim to be an expert on the numbers and signs of what the economy is doing. But I think taking a step away from the data can be more effective in times of increased risk and uncertainty.I think the Fed has been pressured into making this decision by Wall Street and that is not a good place to put themselves. The markets are rallying hard on the back of the decision, not because it thinks a 50 bps cut will save the market, but because it thinks it can call in another cut if anything gets worse.The problem as I see it is a lack of room on the downside to save anyone. The chatter for a serious meltdown is obviously out there. While maybe not a certainty, the potential for a serious housing crisis that leads to shocking cuts in consumer spending and eventually layoffs and recesion is in everyones sights. Yet, the Fed only has 4.75% more they can cut rates before they become Japan and are completely helpless.Other issues I see:
- The BOJ is now completely incapable of raising rates due to Yen-carry unwind risk. This is their fault for not acting quicker, but the Fed does need to take into account the risk they are putting on the dollar.
- Bernanke made a big deal about not doing anything until indicators clearly showed that the economy was in trouble. Yet the theme behind the language was that the cut was more a preventative measure to “help forestall some of the adverse effects [of the credit conditions and housing market] on the broader economy.” I was a big fan of him when I thought he was going to wait until the indicators clearly showed for a change. Not so much any more. Yes, the credit market has wiped itself clean and there are Funds and Banks in trouble, but that is not because of an economic problem but rather a risk management problem of those specific companies. There are plenty of banks that were smart enough not to over-leverage on subprime and are doing quite fine.
- He is creating a bubbble. The markets have brought this upon themselves by taking excess short risk, but in the end, the shorts will win. The market is trading at all time highs while the net short position is also at an all time high. Unfortunately, the shorts will be the institutions, hedge funds, and other smart individuals, and retail will bear the brunt of a crash. Bernanke has just helped spread the gap between the rich and the poor.
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