And Another Rate Cut

Yes, he did it again. Bernanke cut the Fed Funds Rate by fifty basis points, bringing the benchmark rate to 3%. Now that the price of credit is officially below inflation, could the economy finally recover? I don’t think so. Although I’ve read some analyst opinions that some – very, very slim – chances exist that the Fed’s policy will succeed, the reality is that too many problems in the financial and housing sectors need to be solved. Home prices are more than 30% higher than they should be by historic standards, with California median prices 60% above the reasonable level. Until those come down, and that will be a slow, painful process for many a household, bank, lender, and investor, the Real Estate market will not begin to operate properly. With all the mortgages that are about to fail will come huge writedowns and losses at banks all over the world, slowing U.S. economy, higher rates of inflation and unemployment, and all the doom and gloom that those bring along. I don’t really see how changing the interest rate can warp the reality and all the inevitable processes that are slowly unwinding, but the Fed has a job to do, and they’re doing their best. Who knows, it might just work. And by the way, I’m not really keeping score but isn’t it funny how for three meetings in a row, there’s always one – and only one – member of the Fed that votes against a decision. It’s always a different person but I’m beginning to feel there’s a reason why they appoint someone to disagree with the majority. Perhaps it would “scare the markets” if everyone voted for the rate cut? Well… I think they’re quite spooked already; could it really get any worse?

Speculation Grows Ahead Of Fed Meeting

The next Federal Reserve meeting is scheduled for January 30, but with all the dismal economic data in recent weeks and the expected disastrous earnings results at top banks (Citi has just reported an $18 billion writedown in mortgage investments), plans may change. Although the date for the next meeting is only 2 weeks away, there’s belief that Bernanke may summon an inter-meeting to discuss a quarter-, or even half-percentage point rate cut. According to analysts, he may cut some more at the actual meeting. The market is suggesting a 0.75% rate cut, a rare event in the Fed’s practice, with some economists demanding a whole percentage point cut – an unlikely scenario, given the Fed’s concerns over inflation, oil prices, and the dollar’s weakness. Chairman Bernanke signaled that the Fed is ready to take radical action to save the economy, but after all, there’s a chance that it won’t be necessary. I guess the Fed will rather wait for a couple of weeks than summon an emergency meeting.

Unemployment Rises

Unemployment rose to 5% in December, according to the Bureau of Labor Statistics, up from 4.7% a month earlier. Unemployment was expected to grow a modest 0.1% to 4.8%. A significant jump in unemployment like this one may indicate that a recession is coming. A year earlier, the jobless rate was 4.4%. The losses were mainly in construction, retail trade, financial activities and manufacturing, while health care, mining, management and technical consulting services added jobs. It is widely believed that actual unemployment is significantly higher than official statistics would suggest, because the data may be distorted by various adjustments. Unemployment rates for some months in 2007 were revised upwards.

It is believed that weak employment data may pressure the Fed to cut rates at its next meeting on January 30. According to analysts, a half-point rate cut could help the economy avoid a recession, but concerns about the high price of oil and surging inflation remain.

Job Cuts At LendingTree

Mortgage lender LendingTree couldn’t think of a better holiday gift for its employees: job cuts. Unlike Freddie Mac, which took its employees to a party at Ritz-Carlton, LendingTree will be eliminating 220 jobs, which leaves it with some 1,000 employees. This is the third time this year that the company conducts mass layoffs. According to a spokeswoman for the lender, the layoffs were prompted by pessimistic forecasts for the industry. LendingTree posted a third-quarter loss of $5.6 million, compared to profits of $15.2 million a year earlier. The company saw its loan sales plunge due to lower demand by the secondary market, lower revenue per loan and the closing of fewer loans. Since the beginning of the credit crunch in the summer, profits have plunged for mortgage lenders as they tightened their lending standards to prevent future delinquencies and foreclosures. A report by the Labor Department showed that the Consumer Price Index rose 0.8% in October, the biggest jump since September 2005, which will negatively affect the consumers’ ability to make timely mortgage payments, meaning more trouble for lenders. I guess Christmas won’t be very jolly for some companies.

Citigroup’s Chief Economist Forecasts Large Rate Cuts

Lewis Alexander, Citigroup’s chief economist, said he expects the Fed Funds rate to drop 1 percentage point by mid-2008. He believes the Fed will not be concerned about the dollar’s stability because the currency’s value doesn’t affect consumer prices. Alexander, who’s worked at the Fed before joining Citi, is also optimistic about oil prices and the housing market, and believes the U.S. will not go into recession.

All of this is highly debatable, given all the evidence to the contrary we’ve seen so far. Recession is probably around the corner, or already beginning in some local markets, and the dollar’s weakness does affect the prices of imported goods. While a weak dollar benefits the GDP and the job market, its advantages do not offset all the trouble it causes. While a 3.5% Fed Funds rate is not impossible, a great many companies and financial structures will need go under before the Fed cuts this deep. They’ve seen what happened the last time they cut interest rates too low, and they’ll probably look for other ways to prop up the economy. Alexander said energy prices are unlikely to rise from now on, but should the Fed cut, as it is expected to, on Dec.11, oil may well skyrocket beyond $100/barrel, despite the recent drop in prices. Perhaps Alexander is being optimistic, or perhaps he knows something most of us don’t. However, we’ve already seen too many top economists denying the obvious to believe in things the just seem illogical.

Consumer Spending Slowed In October

Growth in consumer spending slowed to the lowest level in 4 months in October, the Commerce Department reported Friday. Spending increased a mere 0.2%, the smallest increase since June. This is slightly below the expected increase of 0.3%. Individual incomes grew by 0.2% as well, which is the slowest pace in 6 months and slower than expected. Gross domestic product increased by 3.9% in Q3, but economists believe the current quarter will not be as robust, with growth possibly slowing to 1% annual rate.

Construction dropped 0.8%, in the 20^th consecutive month of declines for the industry and the biggest decline since July. The slowdown in the housing industry may lead to more layoffs, and even weaker consumer spending. Rising inflation is scaring off consumers and, despite a relatively strong beginning, retailers are bracing for a tough holiday season this year.

Will The Fed Cut Rates Again?

They may want the Wall Street to believe a rate cut is not imminent, but investors are already counting on a 0.25% cut. The central bank released its economic outlook, in which it projected slower growth in 2008, and, quite surprisingly, declining unemployment. The economic growth forecast was revised downwards from 2.5-2.75% to 1.8-2.5%. Meanwhile, turmoil in financial markets is in full swing, with the two largest mortgage financiers Freddie Mac and Fannie Mae reporting higher-than expected quarterly losses.

Shares of Freddie Mac dropped more than 28% after the mortgage giant announced quarterly loss of $2 billion and said it has trouble meeting its capital minimum, which may prompt it to cut its dividend. The company also warned that deeper losses may be coming in the future. Consequently, Countrywide got downgraded by Fox-Pitt, Kelton analyst Howard Shapiro on fears that Freddie’s trouble may mean less financing for the mortgage lender. Countrywide promptly released a statement saying it has “ample liquidity”, but analysts have trouble believing this. So, the Fed may have to cut rates on December 11^th, especially if something big happens as a result of the current chaos. Inflation and the price of oil, however, are still pretty troublesome and if the latter hits $100, the chances for a rate cut are minimal. Time will show.

Fed Announces 0.25% Rate Cut

The Fed cut the Fed Funds Rate yesterday by 0.25% to 4.5%, no surprises here. It also announced that further cuts are unlikely, which sounds logical in the market environment we see. Easing the interest rate some more would prompt [even] higher inflation, so the Open Market Committee is probably done cutting for now.

The dollar dropped to a new low against the Euro yesterday, briefly breaking the psychological barrier of $1.45 per Euro. The currency showed some weakness even before the Fed started cutting rates, but since the September meeting it has been trading at record-low rates against the European currency. According to analysts, $1.50 against the Euro is possible in the near term.

… Which may be bad for the prices of imported goods and oil, but has positive effects on domestic product: the Commerce Department said that economic growth was at 3.9% in the third quarter, the highest level in more than a year. The next Fed meeting will be on December 11^th.

A Rate Cut Seems Likely

As the next Fed meeting approaches, the likelihood of another rate cut seems pretty high, although some doubts remain. The Government is manifestly not concerned about the dollar, as Treasury Secretary H. Paulson vetoed proposals to use the G7 final statement to warn of problems affecting European economies due to a weak dollar. This may mean that the currency will be allowed to fall further, should the Fed decide to cut rates to boost economic fundamentals.

However, another rate cut could accelerate inflation, and with oil hitting the psychological barrier of $90 a barrel, this could be a serious concern weighing on the Fed’s decision. Housing data for September coming later this week will be important for the Fed’s decision, too. There is no doubt that existing-home sales and new-home sales will fall, the question is whether the drop will exceed expectations, and how the Fed will interpret the data.

Subprime crisis scarier than terrorism

A survey performed by the National Association of Business Economics found that experts believe loan defaults and the ensuing financial crisis are the biggest short-term threat to the U.S. economy. Until recently, terrorism was considered the #1 threat. 32% of the participants of the survey named the subprime crisis as the biggest threat to the economy. Terrorism came at #2 with 20%. Other issues on the list included inflation, government spending and the account deficit. The cost of health care was also mentioned as a major concern.

And now that everyone admits that subprime is indeed a problem and that it is already contaminating the entire economy, we don’t really see a solution coming from any of the usual suspects. What we’re seeing is more panic, because the current situation is unprecedented, so analysts don’t know what to expect. Nothing good in any case, I guess.