The Fed today decided to lower the interbank interest rate by 25 basis points. We have not seen many Fed decisions in the past that have received more mainstream press than today's. Why?
The decision today effects a large number of people personally. A large number of homeowners are looking at their mortgages adjusting soon. The current mortgage crisis effects almost everybody in the US and even outside, where banks have to take write-offs from repackaged mortgages they hold on their books, so called Colateralized Debt Obligations or CDOs. The entire effect of the mortgage meltdown is still not know because CDOs are not a liquid assets like a stock. Banks have a lot of room for interpretation when it comes to valuing these assets on their books, just ask Merrill Lynch.
All of this goes directly back to the consumer, who is having an increasingly difficult time to secure mortgages for houses, or to refinance. Consequently, home prices are falling and that effects almost everybody.
Today's move is sensible and may help the liquidity (read: debt) issues. But the Fed rate is a short-term rate and may not have much of an impact on long-term mortgage rates. That remains to be seen. What strikes me is how long this rate cut had already been priced into the markets. As such, the independence of the Fed's decision needs to be examined. How much leverage does the Fed still have when the market practically dictates what it needs to do, and what not?
One other aspect often overlooked is the impact of the decision on the dollar. Lower interest rates mean less demand for dollars, as investors rather put there money where they can earn more for their deposits. The dollar is at historic lows and predicted to loose further in value against the main currencies such as the euro or yen. That works against the Fed decision today as a low dollar potentially means higher inflation, something the Fed is still keeping a weary eye on.
Still, I think today's decision is a sensitive one as the economy is going to slow down. Today's GDP number of 3.9% for the 3rd quarter is higher than expected, however it is widely expected for GDP to be in the 1-2% range only in the 4th quarter. Still, some risk for inflation remains. Just look at the price of oil.
