Interest Rate Roundup

Tuesday, September 18, 2007

Breaking news: 50 bp cut made to both the federal funds rate and the discount rate

Here is the text of the statement. Color me surprised the Fed is moving this aggressively given what has been going on in the commodities and currency markets recently. I expected 25 on the funds rate. Anything can happen, of course. But the initial reaction is a big rally in stocks ... a big steepening in the yield curve (meaning, short-term yields falling but long-term yields rising on the inflationary implications of this cut) ... and a sharp decline in the dollar index.

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4 3/4 percent.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee's last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S.Mishkin; Charles L. Evans; William Poole; Eric S. Rosengren;and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50 basis point decrease in the discount rate to 51/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve banks of Boston, New York, Cleveland, St. Louis,Minneapolis, Kansas City and San Francisco.

UPDATE: Some more thoughts on the move --

This seems a bit mind-boggling to me. We’ve got $81.50-a-barrel oil ... $720+ gold prices … and a U.S. dollar that's been on a severe slide. While the economy has certainly shown signs of weakness, and housing has been in its own private recession, it seems inconceivable that the Fed would cut rates this much. It essentially gives bond traders and currency traders carte blanche to dump the heck out of their longer-term Treasuries and their dollars.

And lo and behold, that’s exactly what’s happening. The U.S. Dollar Index was recently down about a half-point to the 79.22 level. That’s a large decline that leaves this measure of the dollar's value within a few ticks of its all-time low at 78.19 (which dates back to 1992). Meanwhile, long bond futures were down a half point, while yields were up almost 8 basis points (though they are starting to gain some of that move).

I know the stock and housing markets will be happy. So will the politicians. But man oh man is the Fed taking a big risk here with the value of our currency and longer-term inflation.


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