Friday, October 3, 2008

When will the Fed do its "surprise" rate cut?

An open thread: When will the Fed do its "surprise" rate cut?

In Fedthink, the credit markets are frozen now and waiting until the end of the month will only hurt the economy more. In all these Bush, Paulson & Bernanke meetings, there must be intense pressure on Bernanke to cut. There is no way in my thinking that the Fed will wait until its scheduled meeting on October 28/29 to cut rates. Note that the Bank of England announces its rate cut (75 points as the market expects at least 50) next Thursday.

There is a lot of global coordination going on behind the scenes. The ECB's Trichet has been on conference calls with the US government related to this bailout (see the great NY Times article "As Credit Crisis Spiraled, Alarm Led to Action")

I think that the Fed is reluctant to use monetary policy in this way (unlike Greenspan) as they are using more direct tools to free up liquidity. However, they know that they have to break the negative psychology. To some degree, they needed the markets to go down but not crash this week to get the House to pass the bailout. Note that the bailout passage will allow the temporary shorting ban to elapse after 3 business days. Therefore, if the House passes the bill today, the ban would end Thursday morning. Hmm, timed with the Bank of England?

I think the Fed want to avoid cutting after a big down day (like this past Monday or yesterday) so they don't look panicy as they did on the SocGen bottom back in January.

If we close up on Friday on the back of a successful vote in the House, I expect the Fed to cut 50 points either Monday, probably before the open, or Thursday with the Bank of England and when the short ban expires. I would expect the discount rate to be cut 50 or even 75 points.

I also expect Bernanke to have a few other countries to join him in their cut, including Canada , England and even maybe the ECB (which laid the groundwork for a cut yesterday).

Ultimately, I don't think this really matters or works since all the Fed Funds rate does is control the very short end of the government T-Bill market, which is already at near zero rates. The rest of the bond market is where the trouble is, and this will do nothing to help that except a psychologic 1 or 2 day boost. If rates at 2% are not working, I doubt 1 or 1.5% rates will make a big difference.

What say ye? Please give your thoughts....


BBC said...

Adil I appreciate your blog it is so informative. I don't know very much about securities/stock market stuff...could you tell me if the BOC cuts rates, will this cut effect the current fixed mortgage rates..are fixed rates are related to the bond rate? Isn't the 'bail-out' just a way to soften the blow to the US economy? Or is it a bandaid? Things are as you have predicted, how will this bail-out really help other than instill some confidence? Don't get me wrong, that isn't a bad thing but maybe 'a little too little too late'?

Anonymous said...

I guess the gold and commoities may get a short term (day or two) spike after the rate cut

It would b interesting to see all the panic once interest cut is made and it ceases to work....

jen said...

Timely post!

This is from Calculated Risk today:

Will there be an Intermeeting Fed Rate Cut?

Adil Burney said...

BBC: BoC cuts only affect variable rates directly (assuming the banks pass on the savings to the consumer- a big assumption these days given that bank financing costs are rising not falling). Indirectly, fixed rates especially the 1 or 2 yr rates could fall, but again based on the assumption above.

agree that bailout is basically an expensive bandaid and a way to soften the blow...

thanks for the thoughts everyone