With Wreckage Piling Up, Fed Eyes Another Rate Cut
October 27th, 2008WARNING: This is not a recommendation to buy, sell of hold any financial instrument.
DISCLOSURE: I hold physical gold and November call options on GLD.
In a more sane world, one would expect an interest rate reduction to lead to a drop in the value of a currency, relative to that currency’s peers.
With the U.S. dollar, we can’t make that assumption now. The dollar has turned into zombie/carry trade money. It’s cheap to borrow (and about to get cheaper), allowing the borrower to get higher rates of return in other countries. This is yet another short lived scam that will crash down in a flash at some point. However, if the dollar’s astonishing rise continues after the rate cut this week, the above explanation might be the reason why. For more on this, see: Confusion reigns: A crisis-driven global rush to dollar liquidity is not deflation.
To see what happens to carry trade target/victim countries, take a look at the New Zealand Dollar as the Japanese Yen carry trade unwound recently:
New Zealand Dollar vs. Japanese Yen and U.S. Dollar (overlay), weekly interval
Via: AP:
As the economic wreckage piles dangerously higher, the Federal Reserve is prepared to ratchet down interest rates — perhaps to their lowest point in more than four years — with the hope of relieving some of the pain felt by many Americans.
The convergence of a housing collapse and a lockup in lending has created the worst financial crisis in more than a half-century. Alan Greenspan, who ran the Fed for 18 1/2 years, called it a “once-in-a century credit tsunami,” and conceded that he made mistakes that may have aggravated the economy’s slump.
With a recession seen as inevitable, if not already under way, any Fed rate cut would be aimed at cushioning the fallout.
Vanishing jobs and shrinking paychecks have forced consumers to cut back sharply. Millions of ordinary Americans have watched their 401(k)s and other nest eggs shrink and the value of their homes drop, making them feel in even worse financial shape. In turn, businesses have cut back on hiring and other investments as customers hunker down and credit problems make it harder and more costly to get financing.
“These are sobering times,” said Paul Kasriel, chief economist at Northern Trust Co.
All the problems have been feeding on each other. So far, Fed Chairman Ben Bernanke and his colleagues haven’t been able to break the vicious cycle, despite hefty rate reductions and a flurry of unprecedented steps aimed at getting credit flowing more freely again.
Bernanke says he’ll use all tools to battle the crisis.
To that end, Fed policymakers are widely expected to lower the central bank’s key interest rate at the conclusion of a two-day meeting Wednesday — their last session before the November elections.
Investors and some economists predict the central bank will drop the rate by half a percentage point to 1 percent. If that happens, it would mark the lowest rate since the summer of 2004. Others, however, think the rate will be cut by a smaller, quarter-point to 1.25 percent.
In turn, rates on home equity, certain credit cards and other floating-rate loans tied to commercial banks’ prime rate should drop by a corresponding amount. A half point reduction would leave the prime rate at 4 percent; a quarter-point cut would drop the rate to 4.25 percent. Either way, the prime rate would be the lowest in more than four years.
The Fed hopes that lower rates will spur people and businesses to spend again, helping to brace the wobbly economy.
This move blows my mind (what’s left of it). A rate cut? I dunno. I sounds like Bernanke is starting to throw shit at the wall hoping it will stick.
I am not economist! But holy smokes. A rate cut might be good for the carry trade, but I do not think a rate cut is good for investors in the U.S. dollar. Countries like Japan and China who hold most of the U.S. debt are affected by this rate cut big time. A rate cut on interest means a rate of reduction on the interest paid out, as well as the rate to borrow.
Who can or wants to borrow right now? Especially in the U.S. I don’t get it and my whole theory about rate cuts is and or maybe missing some salient feature of economics.
But sheesh.
We learned here in western PA this weekend that PNC Bank will buy National City Bank (PNC’s biggest competitor) and will use BAILOUT funds to buy National City. So yo you taxpayers, if you don’t like it, well go suck on a Twinkie. Fer all the good it’ll do ya.
Re: NZ dollar carry trade with the Japanese yen
from 81 yen to 50 yen in six months is impressive.
but if you look at the 2 or 5 year charts, you see it has spiked up as high as 97.5 in July 2007 (15 months ago) and been in the 80 to 90 range for most of the past couple of years.
When the move comes it comes big time.
During the Asian monetary crisis of 97-98, it went from mid-70s to low 40s in the space of a month or two.
For the last six years, whenever i have visited NZ from Japan, I have been amazed at the local prices for stuff, everyday stuff, converted into yen. Completely out of whack with incomes. Completely out of whack with ordinary supermarket and restaurant prices in Tokyo. And the housing prices were on par with Tokyo, just a bit more spacious. And with complemetary leaky bits.
If the NZ dollar stays around 0.5 USD, and oil goes back up ($200+), we will see a kunstleresque meltdown of kiwi suburbia, IMO.
petrol = NZ$4-5/litre does not make for happy mortgage payments.
a couple of months ago, the pessimist were talking about real estate dropping 30% from the 2007 peak. LOL. 60% seems more plausible.
@tochigi
I have absolutely NO IDEA how the normal Kiwi household manages, month to month. Becky and I made a conscious choice to live a very, very frugal lifestyle, but EVERYTHING seems expensive.
Our property rates (this means property taxes, for readers outside of NZ) nearly doubled. There are the normal gripes about food prices. Our property insurance went up by about 25% (on no claims). The cost of electricity went up again. It’s NZ$ 27.916 cents per kilowatt hour now.
And check this out:
I received new Terms and Conditions that go along with our Farmside satellite broadband service. In addition to increasing the penalty for early disconnection of the service from $299.00 plus GST to $499.00 plus GST (in fairness, the contract length was lowered from three years to two years), there was this:
Farmside broadband plans are subject to limits (data caps) for the amount of data you upload or download each month. If you receive our broadband services via satellite, exceeding the monthly data cap on your broadband plan will result in overage charges. From 3 November 2008, these overage charges will increase from 5 cents to 15 cents plus GST per MB. The price increase reflects increasing costs from our supplier, including the higher cost of purchasing satellite services in US dollars.
Petrol has come down sharply. It’s little consolation, though, knowing that everything else costs more.
Oh well. For dinner, Bex and I went over to her mum’s and dad’s place at Cable Bay. We feasted on a giant snapper that her dad caught earlier in the afternoon. Supermarket squash, spuds, spring salad greens, Becky’s kimchi made out of her dad’s homegrown cabbage. Wow. It was a meal to remember.
All in all, given a choice, this is still the place for us. No regrets at all. (Death to Telecom, though.)
you have got some of the best fishing grounds in the world, at your doorstep. i’m sure your father-in-law could confirm that it was much better in the 1970s, but still, in better shape than most of the world’s fish.
some advice:
skip jack tuna
fresh off the boat
surface seared for less than a minute on a very hot barbecue
plunged into ice water for a minute or 2
sliced into sashimi
served with either wasabi or ginger, soy suace, lemon juice, fresh shiso leaves, steamed brown rice
(if you don’t grow shiso in your garden, please, grow it)
wrt council rates,
i think this is the really weak link in the whole NZ setup. the electricity and telecom ripoffs are bad, but the rates are just going to get hyperinflationary very quickly. they jump out at you after just having read Orlov’s book. to be honest, the only way i can see forward is to massively de-merge all these mega-councils. until the late-80s, each borough/city/county was much smaller geographically. they were forced to merge against most people’s will. funny thing is, in the depopulated Japanese countryside, exactly the same thing is happening right now.
anyway, bon appetit!
@Eileen
I think if they raised interest rates gov’t debt/trade imbalance would zoom by factor’s unknown.
Also people would leave the Wall St.Investment
casino’s.
Low interest rates prior to this point were only
to get the average USALAND greeder hooked on
chasing the money.
Lotta good that did ’em,…anyone got
a 401k to confirm the %30-60% losses
I hear being bandied about?