Friday, August 17, 2007

Fed Finally Wakes Up, Cuts Discount Rate

Thank you, Ben. The market surged at the open this morning after the Fed cut the usually symbolic discount rate. The FOMC unanimously voted to cut the rate at which the Fed lends funds to banks from 6.25% to 5.75%.

This will have a more significant impact in terms of injecting liquidity into the system than the recent open market operations have had. It also opens the door for a cut in the fed funds rate at the upcoming September meeting. Here is a copy of the full statement from today:
  • "Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."

I highlighted what I felt were the important aspects of the statement, namely that the Fed is now acknowledging that the recent market turmoil could impact economic growth, and that the downside risks have increased. Moreover, that the Fed stands ready to act more if needed, to support the economy and prevent conditions from turning into a full-fledged credit crunch.

The Dow surged +300 points at the open, likely exacerbated by the expiration of index options. The sellers have come out since then, and the rally has moderated. But there still could be additional short-covering into the close that could lead to a big day.

I wrote yesterday that I felt a short-term bottom was in the cards. Today's bounce is a good first step. But if you found yourself yesterday wishing you had sold some stuff you owned, then you should use any further market strenght to lighten up.

Asian markets cut crushed overnight, led by Japan's biggest one-day decline since 2001. I have written about the yen carry trade unwind, which undoubtedly increased the severity of the decline.


At 7:59 AM, Blogger Broker Bob said...

United States' Economy Is *INSOLVENT*..... It Is NOT A Liquidity Crises.!!!

There are, however, crucial differences. In the 1990s, there were financial crises, but the flashpoints were in developing countries. This time the problem is in the US itself. Moreover, it is a problem that has been brewing for two decades. In the 1990s, the Federal Reserve, the US central bank, provided cheap money to get the economy going and helped create the biggest stock market boom in the country's history. When the bubble burst, it solved that problem by creating the US's biggest housing bubble to date. The bubble burst about a year ago, but the pain will last for a long time.

Finally, as Nouriel Roubini, economics professor at New York University puts it, there is a difference between crises of liquidity and crises of insolvency. Liquidity crises are those in which firms and individuals have a cashflow problem; interest rate cuts help them through the tough times. Insolvency crises are much more serious; slashing rates makes no difference when people are going bust. The LTCM collapse was a liquidity crisis, Roubini says, and what's happening now is an insolvency crisis.

Hundreds of thousands of households are insolvent, mortgage lenders are going belly-up, construction firms are going out of business, hedge funds that traded complex securities backed by sub-prime loans are going bankrupt. Conclusion? This has the potential to be very serious indeed.


Post a Comment

<< Home