Are Rate Cuts Enough?
Thursday, December 18th, 2008
By George Leong, B.Comm. for Profit Confidential
Never would I believe that U.S. interest rates could fall to zero, but that is simply the reality of the current times. At the Fed meeting on Tuesday, the last one for this year, the Federal Reserve made a bold statement after aggressively cutting the key fed funds rate to the range of 0% to 0.25% in an attempt to pump up the faltering U.S. economy.
It is clear that the Fed needed to try to halt the economic slide in the U.S. The historically low record rates will be an incentive for consumers to spend. Low rates will also be used to try to improve the metrics in the distressed housing and loan markets.
The cheap funds will make it cheaper for corporations to borrow and lower financing costs. We have never seen interest rates this low, so it will be interesting to see if it helps. Just to let you know, Japan had a zero percentage interest rate policy during its recession, but it took quite a while for the country to rebound. So, we expect the same in the U.S., as the situation is bad.
I believe that it will take some time for the low rates to translate into more spending and economic growth. The weak jobs market and declining housing wealth makes it difficult for consumers to want to spend.
I wonder if the reduced interest rates will be enough to get things going. They will help drive some confidence on the part of
consumers and businesses, but you’ve got to wonder about the condition of the economy. I believe that the government will need to do way more in order to try to sway consumer confidence and push up spending. Reduced interest rates will not be enough. The reaction of the market to the rate cut was initially muted after the announcement, but buying did pick up thereafter. Yet, on the world markets, the reaction to the rate cut was absent, as there are clearly concerns that low rates will not be sufficient to reverse the economic engine. U.S. markets also pointed to some selling on Wednesday morning on mixed feelings of the effectiveness of the cut.
The Fed probably realizes this and said it would do whatever it can to turn things around. Clearly the desire is there. I expect to see more incentives for consumer to spend and for corporations to have access to the credit lines. We will have to wait to see if consumers respond and if the economy can strengthen,
My gut feeling is that the worst is yet to come. Things will get worse for the economy before we see a reversal. I believe that the decision of the Fed to lower rates to zero clearly indicates that the U.S. economy is far worse off than we expected.
The stock market remains unconvinced of the immediate benefit of the rate cut. My view remains cautious and, in fact, based on two straight months of declining consumer prices, I am becoming more concerned with the real possibility of deflation surfacing in the country. Consumer prices fell another 1.7% in November, the biggest decline since February 1947. The fear is that deflation will
cause consumers to hold out on purchases and wait for lower prices. And, if this trend continues, spending falls along with corporate activity and this could lead to a more slowing and a potential depression such as the Great Depression, which was impacted by severe deflation.
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George is a Senior Editor at Lombardi Financial, and has been involved in analyzing the stock markets for two decades where he employs both fundamental and technical analysis. His overall market timing and trading knowledge is extensive in the areas of small-cap research and option trading. George is the editor of several of Lombardi’s popular financial newsletters, including The China Letter, Special Situations, and Obscene Profits, among others. His trading advice on stocks and options is also found on his daily trading site, Daily Profits. He has written technical and fundamental columns for numerous stock market news web sites, and he is the author of Quick Wealth Options Strategy and Mastering 7 Proven Options Strategies. Prior to starting with Lombardi Financial, George was employed as a financial analyst with Globe Information Services.
