This is much bigger than the US and Fed alone. Rate cuts are needed and needed soon across G7, and together if at all possible – preferably today. A rescue of the major bond insurers is also a top priority and immediately…in conjunction with a group easing. This is much bigger than the US and Fed alone. Rate cuts are needed and needed soon across G7, and together if at all possible – preferably today. A rescue of the major bond insurers is also a top priority and immediately…in conjunction with a group easing.
But this is what should be done. What will be done? Europe and Japan will not cut rates today. At most the Fed will cut today and probably 75 bps to check contagion and put Bernanke and the Fed back ahead of the financial crisis and recession risk. But even this notion is based on the assumption that the Fed, in all its all-theory-no-practice bungling of late, gets it. And this also requires suspending knowledge of the Fed’s recent past which at best has been a period marked by clumsy policy decisions and market guidance and at worst has been a period marked by policy and assessment blunders.
I am not suggesting a rate cut today is the cure for all that ails markets and the economy. But it would go a long way in restoring confidence in markets that policy makers in the US can get in front of the crisis.
When will the Fed ease? Look for an announcement around 8AM New York time.
Why do I think the Fed does the right thing today? Because it is unfathomable that the Fed can ignore the carnage awaiting US equities and asset managers if the Fed fails to act today. And Bernanke will run the risk of adding to global contagion rather than checking it. The loss in market cap from tumbling global equities provides another headwind for the US and global economy – a negative wealth effect, a similar if less powerful headwind as the housing market negative wealth effect. This is no time to be sidetracked by inflation – commodity prices are falling rapidly and will continue to fall as global demand drops. It is also not the time to be sidetracked by moral hazard risks. This is not about bailing out investors but saving the financial system and hitting a hard landing as opposed to a crash landing.
I don’t think it is worth spending much time discussing why the ECB and BoJ are not ready to cut rates with the Fed (and BoC – look here for half point cut today). The BoE could be talked into a joint rate cut but it is a moot point if the ECB is not involved. Trichet in time will turn to rate cuts, but not readily, not today.
How do markets react to Fed easing? Surely some reversal of recent moves – stocks and commodities rally, bonds sell off, EM firms, yen weakens, euro bounces and dollar index lower. But the real question is whether these moves are sustainable? Clearly without a rescue package for bond insurers surely not.
This is a tall order for the Fed, White House/Treasury and the track record to date is reminiscent of the government response to hurricane Katrina…if the Fed continues its missteps today and the monolines are left to hang, today’s markets will indeed look a lot like the New Orleans Convention Center four days after the city flooded.