Yes, the Fed took a serious chunk out of the fed funds rate and I finally have good news–something happy–to write about. I am grateful. More to the point, though a rate reduction is certainly not a panacea that will solve every problem out there, it will help…at least, for now.
What’s left to be concerned about? For a reasoned introduction to that subject, listen to a recent interview with Alan Greenspan. He’s speaking far more plainly now than when he was the obscure delphic oracle at the Fed.
30-yr Fixed-rate Mortgage 6.86%15-yr Fixed-rate Mortgage 6.551-yr ARM 6.34%[HSH average rates: 30-yr up 11 bps, 15-yr up 14 bps; ARM up 4 bps]Thumbnail Sketch: A growing number of economists are watching today’s economy with increasing concern, fearful that a drop in personal consumption (retail purchases by the likes of you and me) could lead to recession. As Mark Zandi, chief economist at Moody’s Economy.com, states it: “The U.S. expansion is hanging by the thread of business and consumer confidence.” As a result, the decision of the Federal Open Market Committee [FOMC] as to how much of a slice to take out of the fed funds rate had the more sober economists hoping for a 50 basis point reduction (which would give us a 4.75% target rate and reduce the prime rate at most banks by the same amount)…but most, having watched the Fed move very slowly toward a rate reduction, were actually expecting a 25 basis point rate reduction. What were the arguments for and against a 50 basis point rate reduction? It is reasonable to assume that the members of the FOMC were weighing two opposing problems. First, there was the possibility that, without an adequate shot in the arm, the economy might slide perilously downward, as consumers and business leaders lost confidence in its faltering path of growth. On the other hand, there was a genuine concern that, with a rate reduction larger than the usual 25 basis points, markets might react to what they saw as greater negativity and fear in the Fed’s response than they had expected. (Those who have observed the Fed over the years, too, have come to understand that our central bank carefully avoids surprises. Markets tend to overreact to them. So there was good reason to expect a 25 basis point reduction.) That was the backdrop. What we got, though, was a 50 basis point rate reduction. The Fed also cut the discount rate (the rate at which banks borrow short-term from the Federal Reserve) by 50 basis points to 5.25%, clearly signaling a readiness to provide necessary funds to banks. Further, there are less than subtle signals that the Fed will consider future rate cuts. Lastly, it’s notable that the vote yesterday for the rate cuts was unanimous.
As far as the Fed is concerned, therefore, we have moved from an economy in which rising inflation is our predominant concern to an economy in which recession has become our primary worry, and we can reasonably expect that a series of rate cuts is in the offing. The effect of these rate cuts is difficult to predict but, for the short to medium term, at least, it cannot be a bad thing. We receive this decision, therefore, with a degree of gratitude and hope—though we remain concerned about the longer-term future of this economy.