Presumably, the reason for the 75 basis point cut in the fed runs rate announced by the Federal Reserve this morning, which, as best as I can tell, is unprecedented is that the governors believe that the danger of recession due to insufficient liquidity is greater than the danger of inflation. Barry Ritholtz asks several questions:
1) Why Cut today? What was the motivation for today’s cut? Would waiting 7 days have done anything. other than allowing some of the excesses to get wrung out of the system?
2) Equity Market Disfunction? Is it that the equity markets are not working properly? Likely not. Are rates too high? I doubt that’s the reason for any of our economic woes. Then what is it – are lowered equity prices a problem?
Globally, equity markets have been in the process of “Repricing Risk” – why is the Fed disrupting that? Further, there is now a recognition that S&P500 earnings were priced way too high – especially in the event of a European and Asian slow down. That lowered “E” in the P/E adjustment is also under way.
3) TANSTAAFL: The free lunch crowd (a/k/a Long & Wrong) has been chanting for Fed cuts. However, these are not with0out consequences, as Inflation remains a pernicious threat.
Here’s a question: What goes to $5 a gallon first – Milk or Gasoline? How about $6?
4) How Independent is the Fed? The Fed is supposed to be an independent entity, whose mission is a) price stability (inflation) and b) maximizing employment (growth).
and thne makes the observation that’s bedevilling me:
I had no idea that back-stopping speculators and hedge funds was part of their mandate…
Apparently, they’re not worried about moral hazard.
James Hamilton takes a look at the historical record:
The closest precedent for today’s action would be April 18, 2001, when the Fed announced a 50-basis-point cut 4 weeks in advance of its regularly scheduled meeting. The cause on that occasion was intermeeting evidence of deteriorating economic conditions. We now know in hindsight that the economy was already one month into recession at the time of that April 2001 decision.
The Fed’s action appeared to be prompted by turmoil in international equity markets. While Americans were on holiday Monday and still asleep Tuesday morning, London’s FTSE 100 index fell 5.5% and Japan’s Nikkei 225 lost 8.7%. Indian stocks fell so quickly that the Bombay Stock Exchange halted trading.
and quotes Felix Salmon on the Fed’s responding to the equity markets:
There’s one reason and one reason only that the Fed took this move, and it’s the plunge in global stock markets on Monday, along with indications that the US markets were set to follow suit.
with which he’s not in complete agreement, preferring to view the Fed’s act as using the equities market as one method of viewing aggregated public and private information about the future of the economy. He concludes:
My bottom line? I believe the FOMC cast its vote today with those who declare that a recession has already begun.
I can’t help but wonder if the equities markets are responding to the Shanghai market. The traders there have no experience of turndowns: the market has gone up since the founding of this market and I suspect that Chinese investors are very, very nervous.