Fed Rate Cut was unnecessary - Part 2
More Signs are evident that the 50 Basis Point Rate Cut was not only unnecessary but could result into elevated economic problems in the future – Part 2
The 50 basis point rate-cut had a direct negative impact on the U.S. dollar which was already under pressure over the past years but the rate-cut last month gave the U.S. dollar the final push of the cliff.
Some investors cheer the fall in the dollar on hopes that exports will be cheaper for trading partners and experience a decent acceleration.
The same investors that cheer the fall in the dollar hope that the U.S. consumer will continue its pace of spending and therefore the economy seem in decent shape.
Given the above it is important to remember that consumers have a healthy appetite for foreign goods which is one reason why imports are at current levels and the trade deficit runs at roughly $60 billion every month.
Imports have a larger impact then exports, hence the trade deficit, and if consumers continue to spend with current spending habits then the trade deficit is likely to increase as the weak dollar will have a greater negative impact on imports then the positive impact on exports.
One way to decrease the deficit is if consumers either spend less, which would be negative for the economy but very likely unavoidable, or consumers buy more domestic products which requires a complete change of spending behavior among the majority of consumers which is very unlikely to happen.
The U.S. economy is heavily dependent on direct foreign investment which decelerated over the past two months. Lower interest rates together with the huge twin deficits may discourage foreign investment in the future or at least dampen direct foreign investment.
Another aspect to watch out for is diversification away from the U.S. dollar to other currencies. Although this threat is very limited as the U.S. dollar continues at the moment to be a global currency but such diversification has started on a very small scale and is likely to have no impact. However, talks have emerged among bigger central banks to increase the diversification away from the U.S. dollar and some even consider the possibility that the price of oil should not be quoted in U.S. dollars. Once again this threat is very limited at the moment but should not be totally ignored.
Once a certain threshold is reached it is very likely that the diversification away from dollar denominated assets along with the decrease in direct foreign investment in the U.S. will accelerate.
The U.S. continues to loose it position as the single most important country in the global economic landscape and now is part of a basket of countries which are important to the global economy and the threat of diversification away from the U.S. dollar, although minimal at the moment, should not be completely ignored.
Since the U.S. dollar continues to loose its value the spending power of the U.S. consumer also decreased which is often ignored by market analysts. Total equity-market returns in dollar terms are therefore below the actual percentage returns of the U.S. equity markets.
If the Fed decides to lower rates once again the problems will get worse and possibly require more monetary action next year in order to stabilize the economy which will be a negative for the equity markets as rate-hikes may be needed.
One thing the Bernanke lead Fed forgets about is that their economic models do not work in today’s markets. The hoped to move the 30-year treasury yield downwards and help the housing market and the credit markets which did not occur.
On the contrary, the Bernanke ked Fed continues to add to current problems in the housing market and to problems in the credit markets which are likely to increase in size.
If the rate-cut and any potential rate-cuts during the remaining Fed meetings this year will materialize in increased consumer spending the debt-problem of the U.S. consumer, which in many cases is already overextended, will increase in size and the results will have a direct negative impact on the U.S. economy.
Last edited by Triton : 10-15-2007 at 03:07 PM.
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