What happens if there’s no rate in the US Federal Funds rate of the Fed at its April 30 meeting in Washington?
Will financial markets, especially those in the US, swoon at the teat being taken away from them after seeing rates dropped 3% since last September?
Inflation could be a reason for concern and a hold on rate cuts in the US, but it’s not the concern that it is in Australia, China, Japan or Europe.
But after the release of the minutes for the March 18 Fed meeting which dropped rates 0.75%, some testing of sentiment is underway with stories being floated of a possible slowing in rate cuts by the central bank.
"Federal Reserve officials signaled they will slow the pace of interest-rate cuts even as they concluded “some contraction in economic activity” is likely," Bloomberg reported in a follow up story to its initial report on the Fed minutes..
"Some Federal Open Market Committee members saw the danger of a “prolonged and severe downturn,” according to minutes of its March 18 meeting released yesterday. Still, “monetary policy alone could not address fully the underlying problems in the housing and financial markets,” the minutes said.
The Fed dropped benchmark lending rate 2% in the first 11 weeks of the year, the fastest cut in 20 years; there’s $US168 billion of fiscal stimulus, and several steps to increase liquidity in financial markets all to be assessed.
The Fed’s had dropped the Federal Funds rate to 2.25% from 5.25% in September and most economists reckon it will go to 1.25% to 1.75% by the end of June-July.
But what if it doesn’t. After all it has done more than enough to steady the economy and sentiment to the point where the likes of John Mack, the embattled head of investment bank, Morgan Stanley, could tell shareholders yesterday he sees the light at the end of the tunnel.
But he has to be optimistic. If he was a bit more realistic he might worry if that’s the lamp on a loco rushing towards him.
What was interesting about the minutes was the way the Fed staffers seemed to run the debate.
The minutes show the staff told the Open Market Committee members that they had "substantially revised down” their forecast to show a first- half contraction in gross domestic product, with a "slow rise” in the second half. Next year, the staff projected growth "somewhat above” the economy’s long-term potential pace, the minutes showed.
The minutes said some stabilization in US housing markets was needed to "underpin” the economy’s recovery, though policy makers saw "little indication” that the process had begun, the minutes said.
A report Tuesday showed (and we will get more information next week and the week after on new and existing sales) that the number of Americans signing contracts to buy previously-owned homes fell more than forecast in February.
That’s a sign there’s no bottom in sight and the slump in housing will clearly extend well into a third year.
The National Association of Realtors said its index of signed purchase agreements dropped to 84.6, the lowest level since records began in 2001.
The Fed minutes also showed that the question of an "adverse feedback loop,” where lenders reduce credit, hurting growth and causing lending to contract further, was discussed.
"Several participants noted that the problems of declining asset values, credit losses, and strained financial market conditions could be quite persistent, restraining credit availability and thus economic activity,” the minutes said.
The Minutes said: "The staff projection showed a contraction of real GDP in the first half of 2008 followed by a slow rise in the second half," i.e. a recession in the US in the first half; now.
The Fed minutes said, however, that there was a possibility that an economic slump could be lengthy.
"Some (policymakers) believed that a prolonged and severe economic downturn could not be ruled out given the further restriction of credit availability and ongoing weakness in the housing market," the minutes said.
The minutes said the rising prices for oil and other commodities, as well as stressed financial and housing markets, had weighed down on the near-term economic outlook.
"Against this backdrop, many participants thought some contraction in economic activity in the first half of 2008 now appeared likely," the minutes said.
Several participants at the March 18 meeting noted that it had become "increasingly difficult" to value complex mortgage-related securities amid the ongoing credit crunch which is rocking Wall Street.
The decline in the value of such securities has triggered multi-billion dollar losses for some major banks and financial firms: that’s the impact of the subprime mess and the housing slump pushing out of the housing sector to poison the rest of the US economy.
"The ongoing strains were likely to raise the price and reduce the availability of credit to businesses and households," the minutes said.
It could be for that reason that the Fed might sit and wait for a couple of months to see what banks and other financial groups do: whether they lend at existing or lower rates, or even start lifting loan levels. At some stage the Fed will turn off the support, stop exchanging Treasuries for other commercial paper and stop pumping billions of dollars a week into the heart of the markets in cheap loans.
It might just run a quick trial to see how the news is taken and how confidence levels respond, as shown by loan spreads. If mortgage securitisation restarts, that will be a very positive sign.
Big banks though seem to be in rundown mode with Citibank talking about selling $US12 billion in leveraged loans to buyout funds to try and remove unwanted assets from its books.
The rescue of America
