Should the Fed Continue to Drastically Cut Interest Rates?

By: ispeculatornew
Date posted: 03.16.2008 (9:53 pm) | Write a Comment  (0 Comments)

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Wall Street pundits are saying the Fed should lower interest rates by a full point at its next meeting. I think such a rash decision would be unwise and the Fed should actually think about keeping interest rates the same or lowering interest rates by a more modest amount, 0.50 at the most.

It seems the Fed has been focusing more on the stock market than the economy. Earlier this year global markets had a huge selloff when the U.S. market was closed for Martin Luther King Jr. Day. The Fed reacted by unexpectedly cutting interest rates by 0.75 percentage points the next day. It was later revealed that the selloff was caused by forced selling by Société Générale as it wound down trades related to its rogue trader Jérôme Kervie. The Fed, which is supposed to be focusing on the economy, overreacted to what the global markets were doing.

Now, with all the turmoil surrounding financial stocks (Bear Sterns in particular), analysts are calling for another huge cut. I think another big cut would be foolish for a couple of reasons and would once again show the Fed is being bullied by what is happening in the stock market.

First, I don’t think lowered interest rates are going to have much effect on the current economic situation. In fact, lowering interest rates to extremely low levels is what contributed to this mess in the first place. The last time the Fed lowered interest rates to extremely low levels consumers happily took on a ton of debt because they were flooded with offers for easy money. Easy money is was what led to the housing bubble that has burst and it still trying to find a bottom.

This time around consumers have more debt than they can handle. I don’t think lowering interest rates is going to prompt consumers to take on even more debt. Also, even if consumers wanted to take on more debt banks have become a lot more strict in their lending requirements. With all the turmoil in the credit markets I don’t think lenders are going to be in a rush to offer new loans, even if their borrowing costs are lowered. Consequently, I don’t think lowering interest rates is going to prompt consumers to go out and spend more and therefore help the economy.

On the flip side lowering interest rates is what is contributing to the huge rise in commodity prices. Speculators have seized on the theory that commodities should continue to rise as a hedge against the falling dollar. When the Fed continues to lower interest rates the dollar is going to continue to fall and therefore speculators are going to continue to bid up commodities.

The theory that commodities such as oil should go up as a hedge against the falling dollar doesn’t make much sense to me and I think speculators are using any reason to continue to send commodity prices up. If commodities are going up as a hedge against the falling dollar shouldn’t foreign markets also be going up instead of trading in tandem with U.S. markets? Regardless, I’m sure this trend is going to continue and consumers are going to have to deal with higher and higher prices for gas and food. Therefore, lowering interest rates will also hurt the consumer and economy.

I think the Fed should find other ways to help the credit markets besides drastically lowering interest rates. I think the Fed is pandering to whatever Wall Street wants and this could be doing more harm than good.

Disclaimer: I have no position in BSC.

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