Tuesday, September 18, 2007

Did you hear that fat lady sing?

The FOMC surprised almost everybody today when they cut both the discount and the Fed Funds interest rates by 50 basis points (one-half of one percent). I was looking for, like the majority of economist, a 25 basis points cut and then delaying till sometime later, an additional cut in the Fed Funds and Discounts rates.

My concern about a 50 basis points cut at this stage was that the Fed would be using a great deal of fire power all at one time. By using so much firepower at one time I was concerned that the Fed would spook the markets that they knew bad news that the rest of the market does not know. With the Fed taking such a drastic move the underlying message is the economy is in real trouble.

In the “statement” the Fed said that they were clearly concerned about the faltering economy and in particular the housing market. The markets, at least for this afternoon, like the cut in interest rates as shown by the 335 point gain in the Dow Jones index. Tomorrow will being questions as to why such an aggressive move in the first rate cut? How low will the Fed take interest rates before it is over?

The first cut will have its impact in about 45 days with the reduction in credit card interest rates for those cards tied to the prime rate. In fact all loans indexed to the prime rate will see a decline in their cost of borrowing. However, all those mortgages that will be resetting in the next 4 months may not see any relief at all. Many of the adjustable rate mortgages at tied to the rate of interest on Treasury bills, notes and bonds and the rates of interest on these did not move today and depending on how the market views the move today they may not go lower. A concern may develop that the Fed may have been over aggressive and Treasury interest rates many in fact increase.

We will get more information, data, as its called by the Fed, over the next few days and the markets will react to the data. I don’t believe that its up, up and away from hear. The Fed Chairman beings his testimony before Congress later this week and he is sure to be asked, more than once, why he was so aggressive in cutting rates, is he concerned about the economy (code for recession) and what do they think is going to happen to the housing problem? His comments will move the markets, so as for now, enjoy the song because many people and intuitions needed the rally we got today.

Dan Perkins

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