Prague Twin

Monday, September 17, 2007

Drumroll please.....

In the most heavily anticipated FOMC policy decision announcement in the last, well, year at least, most expect the Fed to lower interests rates by 25 basis points from 5.25% to 5.00%. Some believe the rate should (and will) by cut by a full half of a percent. Those folks, I'm afraid, are going to be sadly disappointed.

But what about the others? Will Bernanke cave in to pressure from Wall Street and drop rates to prevent a recession? Are we even that close to a recession? The S&P 500 is up 4.7% on the year. After a hiccup in the Q1, Q2 GDP growth is fairly robust. Inflation has been rather tame in recent months, but will that trend continue especially in light of a rate cut?

And finally, the big question: what about the dollar? The last time I mentioned exchange rates some months ago, the Euro cost $1.31. Now, it is nearly $1.39. Here in the Czech Republic, just over 6 years ago you could literally buy more than twice the local currency than you can buy today for one dollar.

What will actually happen to the dollar if the Fed cuts rates and the ECB raises rates in October (which they are widely expected to do)? $1.45? $1.50? Certainly new record lows for the dollar are in the cards should the Fed lower interest rates. Furthermore, there is some inflation data coming out just before the meeting (PPI and core PPI). What if those numbers surprise to the upside and the Fed cuts rates? What if the CPI numbers which come out on Wednesday surprise to the upside as well? The Fed will look awfully silly cutting rates as inflation fires up. But their job is in fact getting harder every day.

I predicted not long ago that the Fed would hold rates at 5.25% until at least the end of the year. Although I still believe this is the best policy prescription in light of the economic situation, it looks like I'm going to be wrong (again). But don't be too surprised if I'm not. I think the most that the interest rate doves are going to get is a one-time move down to 5.0% with a clear warning that investors should not expect more.

I imagine that even a hawkish tone will keep equities in check for now. There is still a lot of sorting out and unwinding to do. Let's just hope it doesn't happen all at once.

P.S. sorry for the 2 week break. Hopefully, regular program will now continue as scheduled.

21 Comments:

  • I don't know what will happen but I have my money in a safe harbor for now.

    By Blogger pissed off patricia, at 10:52 PM  

  • I'd love to know what that is. Foreign currency? Gold? Foreign real estate?

    For the record, all my money is tied up in my Prague apartment.

    By Blogger Praguetwin, at 12:35 AM  

  • Safe? I read something scary the other day. The writer warned that money market accounts are normally safe, but that's not a guarantee. About 13 years ago, a no-name institutional fund ended up being valued at 96 cents per share. In other words, if you had put $100 dollars in an account, it would have fallen to $96.

    That's enough to send shivers down most people's spines. Brrr...

    By Blogger Kathy, at 1:41 AM  

  • Mine's in the cookie jar - shhh.

    In reality, it's not much better than that. What money I have is in a savings account and fixed-rate 401k funds. It's not the economy I mistrust (altho that's not doing so great these days). It's me. I have as much confidence in my ability to safely invest money as I would to take out my own appendix.

    By Anonymous abi, at 5:28 AM  

  • pissed off patricia, you wrote:

    "I don't know what will happen but I have my money in a safe harbor for now."

    Safe Harbors: US Treasury Securities; bank CDs, bank passbook accounts, bank savings accounts, money-market funds comprising only government securities.

    The short preceding list offers complete safety for available cash

    By Anonymous no_slappz, at 2:52 PM  

  • kathy, you wrote:

    "Safe? I read something scary the other day. The writer warned that money market accounts are normally safe, but that's not a guarantee. About 13 years ago, a no-name institutional fund ended up being valued at 96 cents per share. In other words, if you had put $100 dollars in an account, it would have fallen to $96."

    Your account of the story is only partially true.

    There have been a couple of cases of money-market mutual funds "breaking the buck" as it's known in the business.

    The firms managing the money-markiet funds always kicked in the amount lost. Thus, no customer has ever lost a dime in as a result of problems in money-market funds.

    Management of funds has changed as a result of these rare mistakes. In every case, the fund had too much money in one security. By too much money, I mean the fund had 3% or 4% of its assets in one security as a way to increase the yield. Money-market funds invest in short-term paper, like commercial paper. If a company has a big, sudden and unexpected problem, its commercial paper may lose a lot of its value overnight.

    That paper-loss can hurt the money-market funds that own the commercial paper.

    Anyway, whoever wrote about the money-market fund that "broke the buck" achieved only the goal of scaring people with tales from the past.

    By Anonymous no_slappz, at 3:01 PM  

  • praguetwin, you wrote:

    "And finally, the big question: what about the dollar? The last time I mentioned exchange rates some months ago, the Euro cost $1.31. Now, it is nearly $1.39."

    The cheap dollar will increase American exports. It will also increse the cost of imported goods. The anti-WalMart crowd should love it. The anti-China and anti-India crowd should love it.

    You wrote:

    "Here in the Czech Republic, just over 6 years ago you could literally buy more than twice the local currency than you can buy today for one dollar."

    There's something about the preceding sentence that suggests you think the differnce in the exchange rate reflects some failing of the US rather than some valuable improvement in the Czech economy.

    You pondered:

    "What will actually happen to the dollar if the Fed cuts rates and the ECB raises rates in October (which they are widely expected to do)? $1.45? $1.50?"

    Good news for US exports. Good news for tourists from Europe visiting the US.

    In fact, European buyers would likely find better bargains on many European goods in the US compared with home.

    By Anonymous no_slappz, at 3:12 PM  

  • I predict .25. Won't be too long a wait.

    By Blogger Roger Fraley, at 8:11 PM  

  • Wow a hundred percent wrong. It was 50 basis points. What is the downside to lower interest rates again?

    By Blogger Roger Fraley, at 8:43 PM  

  • NS, Yes, great for exports. Too bad that only accounts for what 5% of the economy? You tell me.

    My point is that the value of your American assets will suffer. The long term implications of a weakening dollar means less foreign money in. Who keeps investing in assets when the denominated currency loses value faster than the investment grows? Fools.

    Roger,

    The downside is inflation. Inflation, inflation, inflation. Here it comes.

    I'm shocked at the 50bsp cut. If they knew that they would take such action in reaction to the mortgage crisis, they should have cut 25bsp last time, or the time before.

    This move seriously diminishes my confidence in the Fed and their ability to forecast future events. I'm really not impressed.

    We are just about at $1.40 now. New record highs. The dollar is plummeting. Look for those moves to continue through the week.

    Honestly, I'm in shock. Unanimous decision? Christ. I can't believe it.

    By Blogger Praguetwin, at 12:50 AM  

  • How long until the US dollar is worthless?

    By Blogger Graeme, at 7:38 AM  

  • Honestly, I'm in shock. Unanimous decision? Christ. I can't believe it.
    Looks like the Fed isn't the only one who can't see the future clearly.

    By Blogger Roger Fraley, at 6:59 PM  

  • Worthless? Never. But 7% a year is not really good.

    Roger,

    Yeah, if they could see the future, they might have dropped the rate by 25bp last meeting instead of double-dipping now.

    By Blogger Praguetwin, at 12:50 AM  

  • 50 basis points can be summed up in two words: "subprime lending." If you drive through my neighborhood there is just too much housing stock for sale out there--much of it bought by investors who thought houses were the best things since tulip bulbs.

    By Blogger Publia, at 5:31 AM  

  • Publia,

    Unfortunately, by the Fed's own admission, this move will do little to alleviate the sub-prime mess.

    In fact, paradoxically, cutting the overnight rate will likely increase inflation pressures which will actually kick up long-term lending rates. We are already seeing a slight steepening of the lending curve with the 2-year yield dropping slightly and the 10-year yield increasing slightly.

    Furthermore, I have been tracking the problems associated with sub-prime lending (in particular 2 year "teaser" rates) for over a year. I refuse to believe that the Fed just now figured out what I've known for over a year.

    If only things were as simple as you suggest, we would have little to worry about.

    Greater forces are at work here.

    By Blogger Praguetwin, at 11:57 PM  

  • praguetwin, you wrote:

    "NS, Yes, great for exports. Too bad that only accounts for what 5% of the economy? You tell me."

    Over 11% in 2006, and climbing.

    By Anonymous no_slappz, at 12:37 AM  

  • praguetwin, you wrote:

    "Furthermore, I have been tracking the problems associated with sub-prime lending (in particular 2 year "teaser" rates) for over a year. I refuse to believe that the Fed just now figured out what I've known for over a year."

    What "problem" have you been tracking?

    There has never been a mystery behind the motivations of people borrowing money. There's no mystery about mistakes people make.

    In short, most people borrowed to buy homes in which to live. Some speculated on the power of their ownership. Some will lose.

    But the houses will remain occupied by the current owners or new owners or tenants. Hardly a disaster for the economy.

    Nevertheless, this stuff makes great headlines.

    Next you should look into the "loan workout" departments at financial institutions. From there you will learn what's next for some of the subprime borrowers.

    By Anonymous no_slappz, at 12:43 AM  

  • NS,

    So the weak dollar helps 11% of the economy, whereas 76% of the economy is based on U.S. consumer consumption. A majority of that consumption is of imported goods (as evidence, see the current account deficit).

    So a weak dollar helps 11% of the economy while nearly 40% of the economy will be adversely affected (not to mention the economies of the E.U. et al)

    Forgive me for not being so optimistic about a weak dollar.

    What problem? The fact that foreclosures are skyrocketing which is now causing a crisis in global financial markets as liquidity dries up.

    Are you even paying attention?

    By Blogger Praguetwin, at 1:53 AM  

  • praguetwin, a few facts about US imports and exports follow.

    But first, a reminder. The largest US import is oil. This is a strategic choice. As I mentioned, exports are 11% of GDP. Meanwhile imports are closer to 20%.

    A cheaper dollar means domestic products become more attractive than imports. If China were to allow its currency to trade freely, it would lose much of its edge in world markets.

    EXPORTS $1.024 trillion (2006 est)

    Export goods:
    agricultural products (soybeans, fruit, corn) 9.2%,

    industrial supplies (organic chemicals) 26.8%,

    capital goods (transistors, aircraft, motor vehicle parts, computers, telecommunications equipment) 49.0%,

    consumer goods (automobiles, medicines) 15.0%

    Main export partners:
    Canada 23%, Mexico 14%, Japan 6%, Mainland China 6%,[8] United Kingdom 3.5%

    IMPORTS $1.869 trillion (2006 est)

    Import goods:
    agricultural products 4.9%,

    industrial supplies 32.9% (crude oil 8.2%),

    capital goods 30.4% (computers, telecommunications equipment, motor vehicle parts, office machines, electric power machinery),

    consumer goods 31.8% (automobiles, clothing, medicines, furniture, toys)

    Main import partners:
    Canada 17%, China 16%, Mexico 11%, Japan 8%, Germany 5%

    By Anonymous no_slappz, at 2:44 PM  

  • praguetwin, you wrote:

    "What problem? The fact that foreclosures are skyrocketing which is now causing a crisis in global financial markets as liquidity dries up."

    You're succumbing to press hype. Ease and availability of credit ebbs and flows. The speculators working at the margins may be under pressure at the moment. Some will fail. Some won't.

    Your tone suggests you think hordes of people will find themselves tossed into the street as a result of foreclosure. Sorry. Won't happen.

    However, some people will have trouble, trouble they brought on themselves by foolishly spending the equity in their homes. This is hardly news.

    The disaster stories in the press mostly focus on people who took out home-equity loans which they used for frivolous purposes.

    By Anonymous no_slappz, at 2:59 PM  

  • NS,

    Thanks for the data. What is your point exactly?

    As for this quote...
    Your tone suggests you think hordes of people will find themselves tossed into the street as a result of foreclosure.


    That is not what I'm suggesting at all nor am concerned (more than anyone should be) with people being thrown out on the streets. People make economic choices, and then they must live with them.

    What is reprehensible and what concerns me is the greater effects on the economy of this "crisis".

    If it is simply just the normal "ebb and flow" of credit, I wonder why the Fed is acting so drastically.

    There will be a price to pay for the loose lending practices and failure to properly price risk across the sub-prime market.

    With the Fed's latest action, they are switching recession risks for inflation risks... or so they hope.

    By Blogger Praguetwin, at 12:25 AM  

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