Will keep trying to ease credit crunch, stimulate economy
The Federal Reserve is expected to cut interest rates this afternoon, making good on Chairman Ben Bernanke’s pledge to do whatever it takes to get the economy back in gear.
“We will not stand down until we have achieved our goals of repairing and reforming our financial system and restoring prosperity,” Bernanke told the Economic Club of New York earlier this month.
James Glassman, economist at JP Morgan Chase, said the market took Bernanke at his word.
As a result, failure to follow though would lead to worsening financial market conditions.
“It would be an odd time for the Fed to get cautious,” Glassman said.
Economists believe that the rate cut will not quickly cure the ailing economy. “Everyone wants a quick fix, but it takes time,” “said Mike Wallace, an economist with Action Economics.
The Fed, which has already taken a series of dramatic steps to ease the effects of the credit crunch that is sweeping world markets, is expected to lower its key overnight lending rate to 1% from 1.5%, bringing the federal funds rate to its lowest since 2004.
But bringing rates lower right now might not help very much, analysts said, because the effective federal funds rate has already fallen to 1% because of a new Fed policy to pay banks interest on the excess reserves they deposit at the Fed.
“The fed funds rate is almost irrelevant,” Wallace said. “The easing has already taken place.”
But Glassman said that there are some benefits to cutting rates and the Fed must keep trying.
“As long as there are benefits they’ve got to keep trying,” he said.
The lower fed funds rate has helped marginally to unclog credit markets and restore some confidence in markets, but credit remains tight despite the Fed’s moves.
The Fed has thrown out its traditional policy playbook in its effort to restore stability to financial markets and cushion the economy.
The aggressive stance is needed because financial market conditions remain hostile to growth and the outlook for the economy grows darker by the day.
The rate cut to 1% would bring the Fed funds rate down to its lowest level since 2004.
Financial markets have already priced in a half-point cut and Fed watchers say the central bank would not like to disappoint investors.
But some see no utility in the move.
“Why is everybody clamoring for rate cuts? What good are rate cuts going to do?” said Robert Brusca, chief economist at FAO Economics.
The problem is that consumers have seen little benefit from lower rates. Banks just are not passing along the lower rates to consumers in the form of lower interest rates on loans or credit cards.
“Banks are like roach motels. The rate cuts go in but they don’t come out,” Brusca said.
“It is like the big players are putting the money under their mattress,” Glassman said.
Josh Shapiro, chief economist at MFR Inc, agreed the level of short-term interest rates is not the biggest obstacle facing the economy but said a rate cut would mainly be aimed at boosting sentiment. It is just one of several buttons the Fed is pushing at the same time.
Confidence is at low ebb because a recession appears certain.
“The combination of what is now a global recession and a still-fragile banking sector will lead the Fed to cut the funds rate,” said Richard Moody, chief economist at Mission Residential.
Growth in the July-through-September quarter is now expected to be below zero, and the forecast for the fourth quarter could be the weakest growth rate in 18 years.
“This is big-time. The economic forecast is remarkably weak,” said Brian Sack, a former Fed staffer who’s now a Fed watcher with Macroeconomic Advisors.
Financial markets continue to be roiled in the wake of the dramatic events of recent months, including the disappearance of major U.S. investment banks Lehman Brothers, Bear Stearns and Merrill Lynch.
Fed Chairman Ben Bernanke “has said that it is important for central banks to be aggressive in times of stress,” said Dean Maki, head of U.S. economics research at Barclays Capital.
The Fed has initiated an alphabet soup of programs to pour liquidity into frozen markets — so far to some, if modest, success.
Earlier this month, the Fed conducted a joint rate cut with its key global partners. Many economists expect the Bank of England and the European Central Bank to also cut rates when they meet again next week.
The Fed statement is expected to observe that downside growth risks are intensifying, signaling that additional cuts could come.
However, the low level of rates has led to inevitable questions of how low rates can go.
Dana Saporta, an economist at Dresdner Kleinwort, said the Fed may cut by a quarter-point next week to maintain some ammunition. Saporta said the Fed will not want to cut the fed funds rate below 1% because that might make life difficult for money-market funds. These funds run into trouble with rates so low, as their expenses are about a half a percentage point.
With the monetary policy textbook having been thrown out the window, many economists have their own theories about unconventional easing possibilities.
Sack said one possibility would be for the Fed to buy long-term Treasurys on the open market in an effort to bring down interest rates.
The Fed has just begun its program to jump-start the commercial paper market by buying three-month commercial paper directly from issuers, including American Express Co. and General Electric Co.
A second Fed program to bolster money-money market funds is still waiting in the wings. These plans are designed in part that they will have adequate short-term funding so that they do not hoard capital.
The Fed statement is expected around 2:15 p.m. In the meeting, Fed officials will update their economic forecasts. Analysts expect sharp downward revisions to the growth outlook and a much higher unemployment rate.
The last Fed forecast was completed back in June — at which time the central bankers were not even forecasting a downturn. Instead, their central tendency showed a period of “sluggish” growth and an unemployment rate topping out at 5.8%.