Monday, 17 September 2007

Will the Fed cut? By how much?, Will it matter?

In short, Yes, 0.25% and No.

The consensus seems to have moved from "Will they cut?" To "How much?" Bernanke wants to carve out a different image than easy Al and he still has one eye on inflation so a 0.25% cut leaving the door open for more is the most likely scenario IMHO.

As to the question of will it matter, an unequivocal 'NO' apart from a short term effect on market sentiment. As mentioned before the Fed will prove how irrelevant they are.

I'm becoming addicted to John Hussman's Monday scribblings. Absolutely great stuff, not because I agree with most of what he says but because he talks common sense and backs it up with well researched evidence. In today's column he succinctly spells out why a Fed rate cut matters:

The Fed: Magical Fairies and Pixie Dust

Wall Street continues to hold its breath about the upcoming decision by the Federal Reserve. There's no question that the Fed's decision will have a market impact. This is not because Federal Reserve operations matter, but because investors believe they matter.

The Fed is, at best, a square-dance caller - the guy who by mutual consent gets to holler out when to swing your partner and when to do-si-do. The Fed provides coordination, but it is a mistake to think it has power. When the barn is on fire and people no longer find it in their best interests to follow along, you can bet they'll dance to their own tune (as we're starting to see in the Eurocurrency market, where LIBOR has significantly diverged from the Fed Funds rate being "called out"). The Fed can provide a modest amount of liquidity to the banking system, but it can't provide solvency to the mortgage market. It's dangerous to believe that a reduction in the Fed Funds rate or the Discount Rate will materially change credit conditions here.

Still, we'll all be gathered there under Ben's helicopter on Tuesday, hoping for a sprinkling of magical pixie dust.

Off to Neverland!

Now that may not seem to be backed up by a lot of well researched evidence. For that you need to click on the heading for the full article. The reason I haven't reproduced the whole article is because Hussman has a reprint policy whereby only a couple of paragraphs can be re-printed and I've decided to respect that.

In a nutshell the Fed funds rate is the overnight rate at which banks lend their excess reserves to each other. This amounts to a few billion dollars, then add a few billion more for funds the Fed lends at the discount window. Then compare those few billions to the $13.8 trillion US economy with $6.3 trillion in loans of which $3.4 trillion are real estate loans and you'll see why the Fed is largely irrelevant.