It seems you have JavaScript disabled.

Ummm.. Yeah... I'm going to have to ask you to turn Javascript back on... Yeah... Thanks.

Rate Cuts: Not A Question Of If, But When & How Much at Trader’s Narrative

NB: This would have been prescient had it been published when I wrote it: yesterday. But thanks to ISP downtime, it comes out now. The crystal ball seems to be working fairly well but perhaps it is time to change my connection to the tubes.

Everyone was waiting and hoping for major help from the Federal Reserve in the form of a rate cut. It was not really a question of will they or won’t they, but rather, when and how big would the cut be?

The Fed Funds futures already was discounting a 50 basis point reduction in the target rate earlier this week (by the next open market committee meeting on October 28th and 29th). So there was no real surprise there. Preempting the Fed, the Australian central bank cut their rates a full percentage point from 7 to 6%. They are also facing the aftermath of a real estate bubble which they allowed to get out of hand.

The global monetary spigot was turned on in synchronous fashion with the European central bank, Canada, Sweden, England, Switzerland each reducing their key lending rates. Even China got in on the action with a 0.27% cut in the 1 year lending rate - but they still have the highest rate at 6.93%.

The question now is, will that be enough? The central banks were already doing other things to help avert a total global financial meltdown. For example, the Fed started to pay interest on reserves held there by banks. Which in essence is a camouflaged Fed Funds rate cut. It also increased the existing term auction facility, which has become an alternative to the discount window used by banks.

The key is not that there was a cut, nor that it was synchronized. But that it was very much expected. So it did not take the market by surprise. Had it been unexpected (how, I’ll leave up to you) or had the rate been reduced by a much larger amount than most expected (say a full percentage cut to 1%) then we would have probably seen the market rally in response. There was only a 40% probability (based on futures market activity) that the Fed would cut 100 basis points before the end of the month. So the market would definitely have been surprised had that happened.

I’ve been pointing out the gap between the Fed Funds rate and the 90 day Treasury Bill rate set by the bond market for a long time now. According to this metric, the Fed has been simply asleep at the switch. The cut should have come a long time ago to narrow the growing gap. But now it may be too little, too late.

fed reserve cuts rates Oct7

The scenario I wish we had seen was one where the Fed would have lowered the rate dramatically about 2 months ago, proactively. And gotten in front of the short term rate set by the bond market. They would have probably had to have kept this rate for a short time (less than a year) but it would have made a dramatic difference because for once, they would have been calling the shorts, rather than being led by the nose.

The danger is that while technically today’s news should help matters, from a psychological point of view, it makes it appear that all the major central banks in the world are desperate. And if they are not successful in stabilizing the credit markets, then they will appear to be in the worst possible position: powerless.

And that is what no one wants to see.

Enjoyed this? Don't miss the next one, grab the feed  or 

                               subscribe through email:  

No Responses to “Rate Cuts: Not A Question Of If, But When & How Much”  

  1. No Comments

Leave a Reply