Panic at the Fed

I don't believe this. The US Federal Reserve Bank has just cut interest rates from 6.25% to 5.75%.

The markets are going wild with excitement. Wilshire 5000 has jumped up 2.38% in about half an hour of trading. That's actually quite a lot.

By doing this, the Fed is essentially pouring money into the market. They did a similar thing back during the 1997 Asian currency crisis to ward off a world recession. The difference this time is that the contagion is in the USA rather than Asia.

I think you're going to see a sell off of US Dollars. This will push up inflation... and the Fed will have to raise the rates again.

To me, this is panic. The New York Times today published an editorial stating that the Federal Reserve should NOT cut rates and instead focus on inflation while letting the market sort itself out. Cutting rates and increasing the money supply is an easy way out... it works in the short term but in the long term it will suck badly.

This is going to backfire - mark my words.

Update: USD has dropped 0.5% against the Euro since the Fed's announcement.

Update 2: The actual cut in interest rates was not the official "fed funds rate" but the "discount window rate". I think the market, like me, thought it was the official rate. As a result the sharemarkets have pared back a bit. Nevertheless, the problem with this move is that it is an effective loosening of monetary policy and will have an inflationary effect.

Update 3: Saturday Evening here and just a quick further explanation of why I think this decision stinks. Basically the entire subprime mess was caused by Monetary policy that was too loose - ie too much money sloshing around trying to find somewhere to go to increase in value. But if the problem was loose monetary policy then the solution shouldn't be loose monetary policy, which is what this announcement by the Fed has actually done.

No comments: