Fed is likely to cut rates again on October 31st
... and continue to add to potential future problems
Everything points to another rate cut by the Federal Reserve on October 31st. The debate may be if there will be a cut of 25 basis points or 50 basis points. The majority expect a 25 bass point rate-cut.
The problems as outlined in the previous three-part series will only be elevated by another rate-cut.
First of all it will give the dollar the final push off the cliff. Many argue that it has been priced into the forex market but the rate-cut has also been priced in the equity markets and there is likely to be another strong rally on Wednesday after the announcement which gives reason to believe that the U.S. dollar is very likely to continue to fall against a basket of global currencies.
The Fed may continue to bail-out those investors that have not recognized the problems in the housing and credit markets but by the same token take a very dangerously stance for the U.S. economy as a whole.
Commodity prices will continue to rise and fuel inflationary expectations as input prices will continue to remain at elevated levels and are likely to push higher which will either cut into corporate earnings or fuel a jump in inflation as those companies will try to pass at least part of those costs on to consumers.
The problems and the impact of those problems which the Fed currently tries to save the economy from have been caused by an extended period of low interest rates to begin with and now as the problems are evident the Fed seems to take a position which will accelerate those problems into the early part of next year.
Any potential positive short-term boost to the economy by the Fed rate-cuts will be offset by increased long-term problems which the U.S. economy is likely to face.
Consumers, which already face a heavy debt load, may now be encouraged to continue to borrow more money to fuel the economy (one reason why a fed-cut is cheered by many investors) and continue to add to the credit problems whose impact on the overall economy the Fed tries to minimize.
The first rate-cut was not necessary and the second one may end up in economic homicide for the U.S. economy going into next year.
Inflation indicators should be expected to rise in future months and input-prices will continue to face upward-pressure. The Philadelphia Fed Survey is just the latest example for that.
The labor-market remains tight and the potential of wage-based inflation is another aspect which should not be ignored.
In a desperate attempt, by a Fed chief which is not qualified to keep the post he currently occupies, to save the economy from a potential recession next year the Bernanke led Fed seems to do the opposite and sacrifices the long-term stability of the U.S. economy for short-term aid to individuals and institutions which did not see the recent problems in the housing market as well as the credit markets.
Exports have benefited from the ongoing deterioration of the U.S. dollar but given the spending patterns of U.S. customers and the aggressive rate-cut last month along with the likely cut on Wednesday has the potential to increase the trade deficit which will add to problems for the economy as a whole.
Given the strong devaluation of the U.S. dollar the U.S. economy as part of the global economy is by no means as strong a figures suggest as the spending power has extremely deteriorated. This is one fact that many analysts and economists seem to ignore during their overall assessment of the economic strength of the U.S. economy.
The Fed is widely expected to lower rates by 25 basis points on Halloween but if for some reason the Bernanke Fed takes a deeper look at the current situation and the strong potential for problems their most recent short-term decision may have and decides to keep rates on hold to assess more data in coming weeks then investors should prepare for a sharp pull-back in global equity markets despite the employment data released on Friday.
Overall, the expected rate-cut is not 100% guaranteed and investors around the globe will closely await the rate decision on October 31st while the majority hopes to cheer a rate cut and the minority hopes for a smart long-tem economic decision.
The Fed’s mandate is to ensure long-term price stability and create an environment which encourages continued expansion in economic activity. There will and there need to be periods of recessed growth and contraction and any attempt to delay such an economic event will only increase and elevate such an unavoidable impact on the economy.
The Fed should have left rates on hold last month and they should do the same this month. It may have resulted in a mild recession and the potential for a quicker recovery. The approach the Fed chose is very dangerous for the U.S. economy and could elevate all economic problems next year which will require a longer time to correct once the economy is faced with the full impact of those problems which in a long-term view of the U.S. economy will be a clear negative.
It is not a smart economic approach to count on strong foreign economic growth as the primary factor for growth in the U.S. economy. The U.S. has long underperformed other mature economies as measured by equity market returns and given the deterioration of the U.S. spending power in a global economy due to the free fall of the U.S. dollar the returns are even less encouraging.