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Uh yeah, I'll take a quarter point cut with a side of dove and a diet misleading GDP

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April 30, 2008 – Comments (12)

I enjoyed predicting what the Fed was going to do last meeting so much (see article: Step right up, place your bet...), that I've decided to do it again.  Like most people, I am looking for the Federal Reserve to cut rates by a quarter point in a couple of hours.  The key here is what its accompanying statement will be like.  In my opinion they should issue a dovish statement, or at least a truly neutral statement, which would be interpreted as being dovish anyhow. 

I'm sure you're saying to yourself, "This guy is nuts.  Inflation is out of control.  The Fed needs to stop already.  They better issue a hawkish statement."  Sure, the falling dollar has exacerbated the inflation problem somewhat, causing oil and grains to rise more quickly than they probably would have.  But you know what, their prices were going to increase dramatically anyhow regardless of what the Fed did with rates.  Underneath all of the talk about a weak dollar, this is a demand driven bull market for commodities created by rising demand from emerging markets for a finite amount of oil and grains.

What the weak dollar that the Fed has created by lowering rates has done is actually mask the underlying weakness in the U.S. economy.  When the government published the first quarter GDP this morning, the headline number was a rise of 0.6%, which was in line to slightly above analysts estimates.  Not to bad right?  Wrong?  The GDP was actually much worse than this when one backs out the increased demand for U.S. goods that the weak dollar has created. U.S. exports increased by 5.5% during the quarter. If one backs out the gains in exports and a build in the inventory of goods that businesses have produced but not yet sold, the GDP during the first quarter actually was -0.4%.  This is would be the first drop since the end of 1991.

Back to why I want a dovish or at least a neutral statement.  The only thing that the Fed will accomplish by making a hawkish statement is make itself look foolish with a small "f" when it has to once again change its mind and cut rates again later on this year or in early 2009 (if the stimulus package delays the inevitable).  The U.S. economy is in much worse shape than the headline GDP number indicates.  A hawkish statement by the Fed today would likely cause a short-term spike in the U.S. dollar.  A significantly higher dollar for a period of several months would probably hurt U.S. exports, which is one of the only things that it masking the true ugliness of the current state of the economy.  Once exports slowed down, the GDP would fall off of a cliff and the Fed would have to cut rates anyhow, making itself look stupid in the process for stating that it wasn't going to. 

There's nothing wrong with slowing down the breakneck speed at which the Fed has been lowering interest rates, but to completely rule out future cuts would be a huge mistake.

 

Deej

12 Comments – Post Your Own

#1) On April 30, 2008 at 1:19 PM, GS751 (27.67) wrote:

What I wonder is what is going to happen when they cannot cut rates anymore.  Make up new things like the TAF.

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#2) On April 30, 2008 at 1:52 PM, TMFDeej (99.40) wrote:

Good point, GS751.  That's why I don't mind the fact that the Fed is slowing the pace of the cuts.  The Fed can continue feeding quarters into the Recession Fighter game for a while before they run out.  Ohh, I just came up with an arcade reference.  I like it.  We need to think of a better video game title than that, but I like the whole feeding quarters into the machine analogy.

Deej

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#3) On April 30, 2008 at 2:21 PM, TMFDeej (99.40) wrote:

Wow, I nailed it again.  First with the 75 basis point cut last time when everyone else was looking for 100 to 125 and now with the 25 point cut and a dovish statement.  Perhaps I should play the Fed Funds Futures market ;).

Deej

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#4) On April 30, 2008 at 2:28 PM, TMFDeej (99.40) wrote:

Perhaps I spoke too soon.  Check out the difference in these two headlines:

CNBC: "Fed Reduces Rates to 2%, Hints It May Not Be Done" 

CNN/Money: "Fed cuts rates again and hints at pause"

I wonder which one is right?  I need to read the darn statement for myself to figure out what the Fed actually said.  That will teach me to trust the media to interpret anything correctly.

Deej

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#5) On April 30, 2008 at 2:28 PM, TMFDeej (99.40) wrote:

Perhaps I spoke too soon.  Check out the difference in these two headlines:

CNBC: "Fed Reduces Rates to 2%, Hints It May Not Be Done" 

CNN/Money: "Fed cuts rates again and hints at pause"

I wonder which one is right?  I need to read the darn statement for myself to figure out what the Fed actually said.  That will teach me to trust the media to interpret anything correctly.

Deej

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#6) On April 30, 2008 at 2:35 PM, TMFDeej (99.40) wrote:

And the loser is...CNBC.  A minute after posting the headline "Fed Reduces Rates to 2%, Hints It May Not Be Done"  it revised it to "Fed Reduces Rates to 2%; Future Moves Unclear."  Let's hear a big BOOOOOOO for CNBC.

Deej

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#7) On April 30, 2008 at 3:04 PM, mandrake66 (93.70) wrote:

I don't think the Fed has much leeway to lower rates further. Short-term real rates are now negative. I don't think they have the ability to go much lower, though admittedly my understanding of how they accomplish this technically is pretty limited.

Krugman was speculating on this a few weeks back. My impression was that rates are just about as low right now as the Fed can actually drive them realistically. 

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#8) On April 30, 2008 at 3:21 PM, TMFDeej (99.40) wrote:

Here's a telling quote about today's GDP from an article in Business Week:

"But on closer scrutiny, the Commerce Dept.'s report shows the most weakness in 17 years in actual domestic demand for goods and services."

GDP Growth: Recession Averted?

 

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#9) On April 30, 2008 at 3:21 PM, TMFDeej (99.40) wrote:

Here's a telling quote about today's GDP from an article in Business Week:

"But on closer scrutiny, the Commerce Dept.'s report shows the most weakness in 17 years in actual domestic demand for goods and services."

GDP Growth: Recession Averted?

 

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#10) On April 30, 2008 at 3:30 PM, Gemini846 (57.23) wrote:

Face it, Bernake has some aids that aren't that hot at math and just wanted to round off to the nearest %. :P

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#11) On April 30, 2008 at 3:33 PM, Tastylunch (29.19) wrote:

I'll go with bloomberg (who I like better anyway than CNBC or CNN/Money) for the tiebreaker.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a06_BuKejUmc&refer=home

Fed Trims Rate to 2%, Signals Ready to Consider Pause (Update2)

but man is the Fed vague as usual

`The committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability'

I read that as no more rate cuts are needed in the near term but the Fed reserves the right to do so in the future should they think it's necessary.

i.e. they said nothing one way or the other, other than that there probably won't be a cut at the next meeting.

 this part of the article made me nervous

Five-year-ahead inflation expectations measured by the Reuters/University of Michigan survey rose to 3.2 percent April, the highest level since October 2005.

``If they do lose credibility as an inflation-fighting institution, they will find it much harder to do anything,'' James Hamilton, an economist at the University of California, San Diego, said in a television interview before the meeting. ``It is a slope you do not want to start sliding down, and I am afraid the Fed has already started.''

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#12) On April 30, 2008 at 3:46 PM, Tastylunch (29.19) wrote:

oops didn't refreash to see the new comments after comment #5

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