US Slashes Interest Rates

Rob Mackrill - Wed 23 Jan, 2008

If it were done when 'tis done, then 'twere well It were done quickly. - Macbeth Of course, old Macbeth had killing a king in mind, encouraged by his harridan of a wife. In contrast, Ben Bernanke is on a mission of resuscitation with Wall St and The White House on his back. With a deafening toot on the cheap money horn he hopes to blow some life back into credit markets...consumer spending...house prices and stocks worldwide...

“If it were done when 'tis done, then 'twere well It were done quickly.”

- Macbeth

Of course, old Macbeth had killing a king in mind, encouraged by his harridan of a wife. In contrast, Ben Bernanke is on a mission of resuscitation with Wall St and The White House on his back. With a deafening toot on the cheap money horn he hopes to blow some life back into credit markets...consumer spending...house prices and stocks worldwide.

Both the old murderer and the new(ish) central banker seem to have arrived at the same conclusion as to how to go about their respective tasks. If it’s got to be done, don’t pussy foot around. Strike hard, strike deep and strike fast. Slashing 0.75% off the Fed Funds rate is doing a lot very quickly... a “super cut” as Dan Denning, of the Daily Reckoning Australia, calls it. Its urgency was emphasised by an 8-1 vote of the Open Market committee in an unscheduled meeting. The scheduled one comes next week when perhaps they’ll be back for more. Hasty to the point of panic is the impression, but maybe that’s the point. This is serious and now the world knows it. Aboard the train of the global economy, when Uncle Sam’s engine splutters the wheels on the rest of the world’s coaches start falling off soon after. We don’t doubt ‘decoupling’ will come, but the Chinese and Indian engines are work-in-progress, and until they’re reporting an obesity problem on the scale of the Anglo-Saxon nations, we’ll have our doubts.

The super cut takes the rate down from 4.25% to 3.5% and turns the real interest rate negative once again, based on 2007 inflation of 4.1%. This is a big shot looking for a knock out but if the bruiser on the receiving end gets up again there’s less ammunition for another go. Slashing rates softened the blow of the dotcom bust, so the same medicine should work again. But the virus is a little different this time around. The US consumer is debt rich and cash poor with a zero savings rate at best, flat to falling real earnings in the past few years, and a home that is falling in value. Hardly a feel-good place to start being flash with your wallet.

It may have trashed the dollar but cheaper money breathed life into stocks. Though the Dow closed down 128 points, it was almost a triumph given the 500-plus point crash suggested beforehand by the futures market. In the UK, the FTSE 100 had a truly schizophrenic day on Tuesday. Having gone straight into freefall by more than 200 points at the open, it closed up 164. Traders brave enough to play must have either made or lost a fortune. Asian stocks have rebounded on the prospect of yet more containers heading Wal-Mart’s way. Hong Kong’s Hang Seng leaped more than 10%. Europe today is a little more circumspect and London stocks have been unsettled by news from the last Monetary Policy Committee meeting. More on that in a mo’.

So where does this shifting of the biggest of the monetary tectonic plates leave the UK? A “mini US”, with a similar list of ailments. Don’t expect some big showboating move from us, Mervyn King said in a speech yesterday...in so many words. We’re stuck between a rock and a hard place. While a slowing economy may call loudly for cheaper money, bubbling inflation is whispering ”it’ll come back and bite you if you do”. Inflation could match its highest level in a decade, reckons King, as he refills his pen in anticipation of another of those explanatory letters to the Chancellor.

“To put it bluntly, this year we are probably facing a period of above-target inflation and a marked slowing in growth... We face a difficult balancing act in the course of 2008, but we start the year in a position in which bank rate, at 5.5 percent, is probably bearing down on demand.”

So what should we expect from the Bank of England? 0.25%...0.50%? Call it 0.50%, says ex-Monetary Policy Committee (MPC) member DeAnne Julius on Channel 4 News last night,...and do it now. The Bank is behind the curve and at a hefty 5.5%, still “bearing down on demand” and at a “tightening” level. Stick them at neutral for a start says she.

But her views may be a little out of step with the current MPC members judging by the release today of the voting at the last meeting. It was a close call, they said beforehand. No it wasn’t. It was near unanimous 8-1 hold. What are they seeing which others missed wonders Mr Market? He’s not sure and is not sticking around to find out. The FTSE 100 was down 100 by late morning. Other European markets are showing similar form...or lack of it. Nice try, they seem to be saying, but we’re not falling for it.

To date $100bn of credit losses has been accounted for. Another $5bn write-down from Bank of America slipped under the radar in the hubbub yesterday. Courtesy of one time Labour PR girl Jo Moore: It was ‘a great day to bury bad news.’ The banks have lost 30-40% of their lending capacity, says market commentator David Buik on the radio... and then there’s the insurers... This credit bear has a long way to run, and the era of cheap money is as moribund as king Malcolm after the treacherous Macbeth had done for him.

Hubble bubble toil and trouble... 

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.