(or 1:15pm Central Time)
Yesterday was one of the most anticipated Federal Open Market Committee meetings in recent memory. The economy has been showing signs of slipping, housing was continuing to weaken and the futures markets were evenly divided on a .25 and a .50 cut in the federal funds rate.
At 2:15pm EST, when the announcement was to be made, I was linked in to WSJ, Yahoo Finance, MSN Money, and several other sites and was having a problem loading them as 2:15 approached. It was kind of like the drop in water pressure experienced when there were commercial breaks during the original I Love Lucy Show in the 1950’s (note to Clark: it was before I was born).
Should the Federal Reserve lower the federal funds rate? The Fed had just dropped the discount rate a few weeks ago to little apparent affect, other than to assuage (is this a word?) investor concerns. The federal funds rate hadn’t been lowered since 2003 and there were concerns that a .50 move would rattle the markets. Wrong!
Stocks surged after the Federal Reserve’s interest rate cut Tuesday as investors viewed the half-point reduction as strong medicine that would avert a recession.
The Dow Jones industrial average shot up 335.97 points, or 2.5%, to 13,739.39, its biggest one-day rally since April 2003.
Not only had the Federal Reserve cut the federal-funds rate by a half point to 4.75%, it cut the discount rate by a half point to 5.25%.
The Bloomberg Terminal I had access to through Radar Logic showed a wild spike in the DJIA immediately after the announcement… resounding vote of approval from the markets. However, treasury yields rose a bit afterwards on concerns over inflation, however, today’s CPI announcement shows it to be less of a concern: core cpi up .2 and non-core cpi down .1 suggesting limited inflation risk.)
I also found it slightly humorous (in an economic sort of way) that there were those that thought the fed should not help the housing market as a way of punishing borrowers, lenders and Wall Street for making bad credit decisions. Hey, you can’t separate housing from the rest of the economy. The painful lesson here has been a rediscovered understanding of what risk actually is. If decisions are based on a lack of understanding of what the underlying asset is, then a wildly volatile variable has been introduced into the risk decision.
Immediately, the National Association of Realtors posted a (what I assume to be a pre-packaged) press release that said:
“We believe that the Federal Reserve Board made the right move today in lowering the interest rate,” said Pat V. Combs, president of the National Association of Realtors Â® and vice president of Coldwell Banker-AJS-Schmidt in Grand Rapids, Mich. “Making borrowing more affordable will make money more available and this could go a long way in helping turn around the sluggish housing market.”
Will the fed move turn around the housing market?
I don’t think so. I think it slows the bleeding. More cuts would need to be applied, excessive inventory would need to be absorbed. Remember the old days are over. Lenders are actually following their lending guidelines rather than bending over backwards to allow exceptions and investors have largely dissappeared. The flow of transactions will likely remain at much lower levels than a few years ago.
Bill Gross of Bond fund giant PIMCO, who had called for the cut, says there is another 1% drop needed in the federal funds rate before.
Housing will provide the impetus to lower and lower fed fund yields
Confidence among U.S. homebuilders tied a record low in September as more lending restrictions and higher borrowing costs concerned buyers, a private report showed today.
To keep economic growth near 2.5 percent or 3 percent, that implies “ultimately at least a 3.75 percent destination for fed funds,” Gross said.
Only twice in the last 20 years has the Fed started a rate cutting cycle with a half-point reduction, Gross said. Both times, the economy fell into recession, he said.
In other words, housing is part of the economy. With that epiphany, now lets try to build in some intelligent mortgage safeguards.