Why The Rate Cut Was Important To Main Street

The Federal Reserve lowered the Fed Funds rate on Wednesday to 1%. The move was widely expected but it's still important for a few reasons. First, Main Street was expecting it and now is not the time to disappoint people after they have had the shock of opening their 401-K statements. Lowering the short end of what we call the yield curve allows banks to borrow at a cheaper rate and that will help with their level of profitability. Also, a lot of household and business debts are tied to the Fed Funds rate and lowering the rate lowers the interest charges consumers have to pay. Many mortgages are tied to the Libor rate which is why we have been so focused on it, but the lower Fed Funds rate still helps. On Libor for a second, it has been trending down nicely and John Ryding of RDQ Economics expects the rate to go to 2.25% early next year (against 3.41% now.)

What we now want/need to see is the European Central Bank and the Bank of England lower their rates when they meet (separately) on November 6. The current ECB rate is 3.75% and the BOE rate is even higher is at 4.25%. It is almost as if they are in some stage of denial with rates at that level and the economies of the world faltering like they are. There are more economists rushing to lower their estimates of Q4 GDP to a -4% or so. Q3 is reported Thursday and the guess is for a slightly negative -.5%. From there to a negative 4% in the U.S will recoil around the world and the ECB and the BOE are behind the curve.

What will help in 2009 is the fall in the price of oil, presuming it stays down. Every .01 cent decline in the price of gasoline saves the U.S consumer $3.4 million a day. That would be $447 million a year. That will come at a good time since unemployment will rise and the inevitable rise in the jobless rate will be at least partially blunted. Oil averaged $72 a barrel in 2007 and is probably averaging around $105 year to date, so the biggest impact will be felt next year.

The depressing truth comes from J.P. Morgan's investment group that figures the trailing ten year return on the S&P 500 is negative for the first time since 1937. Ouch! But then again, maybe this is an opportunity.

Comments

[emerywood]

Considering how much money has evaporated, gone, from our financial system, no matter how much the government is subsidizing or lowering interest rates, things will never be the same again either for the banks, the financial system or for the general public. We just have to get used to it and hopefully, don't get into a great depression or worse. It would indeed be a miracle if things can turn around in a year or two.

[JBS]

You'll see that rate cut reflected in the interest rate banks pay for your savings, but there'll be no change in the interest rate on your credit cards.

[Pdubya]

And what about the purchase power of our currency? So what if I don't have to pay more interest? If the 2% reduction in interest doesn't buy me a 3% savings because the currency is devalued (by dumping more fiat currency into the system), all its doing is putting life support on a brain dead patient.

Credit comes from savings, not more credit. Banks can lend easier? Lets rephrase the answer: people don't want to borrow anymore.

[Ratt]

FTA: Also, a lot of household and business debts are tied to the Fed Funds rate and lowering the rate lowers the interest charges consumers have to pay.

Hmm, I don't see how you can say that. When the Fed Rate was 3.5% the Consumer Mortagage Rate was hanging around 6% , now the Feds have dropped another Bailout into the hands of the Bankers and Wall Street with this 1 % Lending Rate and there was no trickle-down effect to Consumers because the Mortagage Rate is still hanging around 6%, , and make note here; the 1 % Rate is the Rate paid between the Feds and the Rich Bankers and has no bearing at all on what Joe The Plumber pays, and and, it seems the gifts keep on coming to Wall Street with the $700 Billion Dollar Bailout and now the Fed Rate cut to 1%.

So, I guess my point here is the Consumer is the last one to get a break, and normally doesn't get one till hardtimes come. If the Bailout had not come we would have seen 3 - 4 % Mortgages and now that would have helped out the poorly consumer.

[MilwaukeeDan]

Ratt, you're right, but the bailout is going to cost more than several trillion dollars. They are bailing out gamblers as this crisis is not caused by mortgages, but by gamblers on Wall St betting(CDS)on those motgages going bad. The consumers will get a "stimulus check" and we'll just add to the deficit.

[MilwaukeeDan]

OK, good point Mr. Farrell, but the underlying problem of this country is middle class wage stagnation, inflation, rising debt and job loss, no one has addressed this issue.