US Interest Rate Cut Not Enough?

Rob Mackrill - Wed 12 Dec, 2007

An interest rate cut boosts asset prices, no? Well not yesterday. The US stock market blew a huge collective raspberry at the Feds decision to shave 25 basis points off both the Fed Funds rate the overnight bank lending rate - and the discount rate - the rate at which commercial banks borrow from the Fed... Investors saw this as a given and clearly more like half a per cent was the aspiration. The markets response seems to reflect cracks in the general assumption that the Fed is there to bail it out. Theyre putting a Band-Aid on an open wound said one credit strategist in the Wall Street Journal...

An interest rate cut boosts asset prices, no?

Well not yesterday. The US stock market blew a huge collective raspberry at the Fed’s decision to shave 25 basis points off both the Fed Funds rate – the overnight bank lending rate - and the discount rate - the rate at which commercial banks borrow from the Fed.

Investors saw this as a given and clearly more like half a per cent was the aspiration. The market’s response seems to reflect cracks in the general assumption that the Fed is there to bail it out. “They’re putting a Band-Aid on an open wound” said one credit strategist in the Wall Street Journal.

Part of the disappointment could be that the discount rate was not cut by more, points out John Authors in the FT. Now at 4.75%, it is half a per cent higher than the Fed Funds rate at 4.25%. At a time when cash-strapped banks are looking for liquidity, more help was expected from the lender of last resort to make it a ‘relevant’ source of new funds.

The Dow which had been up on the day before the news slumped 294 points and treasury bond prices soared. More on the subject from Bill below. European exchanges are showing their disappointment too. The FTSE 100 is off 33 points at mid-morning, at a tad over 6,500.

It is a significant moment for the UK’s leading share index. The imminent quarterly index reshuffle may well witness the biggest changes since 2001. Northern Rock is an obvious candidate for ejection which will see its shares once again under pressure as the index tracker funds sell out. It may be joined by a number of other others that have fallen out of favour with investors such as pub landlords, Mitchells and Butlers and Punch Taverns, house builder Barratt Developments, sugar manufacturer Tate & Lyle, consumer electronics retailer DSG International (formerly Dixons) and Daily Mail and London Evening Standard newspaper publisher, the Daily Mail & General Trust.

More news on the slowdown...

A report by Reuters says property development has fallen for the first time in four and a half years. And the Times’s Patrick Hosking puts a name to the “mystery” financial institution rumoured to be in discussions with the FSA about halting trading in its property fund. Aviva plc. The insurance giant has ‘not denied’ the rumours surrounding its £3.7bn Norwich Property Trust, the big daddyfund in the sector. So lo and behold, here comes the next mis-selling scandal bowling down the track...

Consumer businesses continue feeling the pinch. Whitbread joins Clapham House in reporting a slowdown in its restaurant trade. And the bingo hall business is “challenging”, say Rank, as they axe their dividend and investors make like a banana and split. Sales from its Mecca bingo halls have slumped 18% since September 1.

In the City the job losses are starting to come. Canadian bank CIBC announces it is laying off 60, and more may follow. Dresdner Kleinwort is cutting 200... many of them City-based. And accountants BDO Stoy Hayward see more businesses going under next year than at any time since the dotcom bust.

But there is good news in the unemployment numbers. UK unemployment hit a 32-year low, at 813,000. We’ve come a long way since 1979, when Margaret Thatcher first got elected, helped into office by 3m unemployed and the advertising slogan: “Labour isn’t working!”. On the flip side, such a tight labour market means the prospect of rising labour costs pushing up inflation. Still, let’s just call it good news for now.

*** Comment on the UK’s subprime experience...

"Dubious advice from brokers, irresponsible lending decisions and aggressive arrears management by sub-prime lenders are driving the current increase in mortgage arrears, court action and repossessions.”

"Our research suggests that many aspiring home owners have been mis-sold unsuitable and costly home loans that are doomed to fail from the start.”
"Many sub-prime lenders are flouting the rules on responsible lending by granting loans when it's clear the borrower will not be able to afford to repay it from the very outset, then getting tough immediately things go wrong."

These are excerpts and comments from a new report by the Citizens Advice Bureau based on 1,200 case studies in England, Wales and Northern Ireland.

Now onto the real business of the day...the school play.

Last December your editor joined a throng of expectant parents and grandparents crammed into the school gym armed to the teeth with broad smiles and slim camcorders to squat on benches designed for the under fives. The play that year was called ‘Donkey for Sale’ – a suitably inoffensive quasi-Nativity story for our trussed up religiously anodyne times. It was a blizzard of bewildered four year olds, assorted home-made costumes and mumbled lines or crisper prompts.

This year the play is called ‘Collateralised Donkey Obligation Gets Written Down to Diddly Squat on Our Revised Pricing Model Assumptions’ (so plunging the whole Crib scene into loss for the year and forcing the Innkeeper into ‘early retirement’). Just kidding...

Our five year old has the part of a ‘page boy’ having been an ‘angel’ last year. Whether this is a modest move up the lower ranks of the thespian pecking order is unclear. We’ll just have to see if he gets the chance to fluff a line or two this time around. 

This article is from The Daily Reckoning. With over 500,000 readers every day The Daily Reckoning has become essential reading for anyone who’s interested in their money. If you think you'd enjoy witty, irreverent and often hilarious commentary on economics and investment - for FREE - then sign up today.