- The media treats a rate cut by the FOMC next week as a foregone conclusion, believing it's necessary to "save" the economy from a credit crisis.
- We continue to view credit crisis fears as largely psychological.
- A rate cut won't even impact much what everyone fears—availablility of liquidity for low-quality, long-term loans.
- We view a major monetary policy error as a greater risk than the "credit crisis"—though that risk still remains very low.
Here we go again. As the FOMC prepares to meet next week, there's no "will he/won't he debate"—the media's decided Chairman Bernanke will cut, and it will be just what the doctor ordered.
Waiting on a Cut
By Liz Rappaport, TheStreet
Fed Rate Cut May Hinge on Where the Libor Goes
By John M. Berry, Bloomberg
US Rate Cut Hopes Offer Respite
By Michael MacKenzie and Geoff Dyer, Financial Times
We don't get in the game of handicapping Fed actions—but we wouldn't be surprised if Mr. Bernanke does cut rates again. Whether or not he needs to, that's a different story.
Credit crisis fears are back with a vengeance, and like any true correction W-bottom, there's a slight twist. This time, the story is lenders have been hiding more "toxic debt," and their earnings are doomed—possibly forever. That will seep out to infect Financials, the broader economy, consumers, the toads falling from the sky, and the four horsemen trotting in Apocalypse formation down your street.
Do we need a Fed bailout? We didn't think so this summer and we don't think so now. Let's examine the facts. Credit spreads are widening again—and widening spreads can be a good indicator for credit market trouble. But what's really going on?
Most of the credit spread movement is coming from the 10-Year US Treasury rate dropping to year lows. Note: When the 10-Year rate rose above 5.3% in June, the media warned rising long-term rates signaled a dying bull. Now dropping rates are a sign of trouble. Rising 10-Year = bad, but falling 10-Year = worse?
Corporate bond rates are falling too—BBB rates are lower than this summer and AAA rates are lower than they've been all year. They're just not falling as fast as the risk-free rates, hence, widening credit spreads. Borrowing rates getting cheaper isn't what we generally see in a true credit crisis. Nor is it something that normally kicks off a recession. Rates on high-yield bonds (i.e., "junk") have moved higher, but they're still nowhere near levels we saw in 2000 through 2002.
Still, folks demand a rescue. Enter Super Ben! But the funny thing is the "rescue" will be another Federal funds target rate cut. But a Fed rate cute actually has little impact on the thing everyone fears—availability of liquidity for long-term, low-quality loans.
When the FOMC drops the rate target, it's a little cheaper for banks to lend to each other overnight. That might lower the rate banks pay you for short-term deposits—CD rates could drop! Some adjustable-rate mortgages come down a bit. But that likely won't impact the majority of mortgages much—their rates aren't directly linked to Fed funds, so the FOMC can't launch much of a "rescue."
Rate cuts do lead to more money in circulation—increasing liquidity—and isn't that what everyone wants? That's what folks think they want, but endlessly printing money isn't a good idea either (and still won't "solve" subprime). If Mr. Bernanke pushes the pedal to the metal and floods us with cash, a few years down the road, the media will have long forgotten about that silly "credit crisis" and be squawking for a government fix to our runaway inflation.
Though we don't think a rate cut is necessary, we still view the risk of a major monetary policy error as low. The reality is rate moves take a while to be felt—though in the near term they can impact sentiment. But sentiment's short lived! Example: Just this summer, Ben was praised for "saving" the economy . . . and here we are again . . . demanding another save.
We still think it's likely Mr. Bernanke's signaling to the next President he can be an accommodative guy—in a bid for reappointment in 2010. Nothing wrong with that, as long as Mr. Bernanke doesn't go overboard. And if it helps investors over their correction psychology, so much the better. A fake rescue for a fake credit crunch.
For more on our views on our healthy economy, read
- The Exclusionary Economy (Everyone but Me!), 11/29/2007
- Dopey Dow Theory, 11/27/2007
- Imagine: The Gaia Economy, 11/23/2007