Today we will, in all likelihood, see a cut in the Fed funds rate.
But, by of what size, and, if it does happen, will it actually mean anything?
Bank of America economist Peter Kretzmer, for one, is expecting a lowering of 50bp to 1 per cent:
As the crisis has unfolded, recent releases have indicated that the psychological impact of the recent financial market disruption, including the declines in asset values, is the greatest in more than a half century. For example, this morning’s consumer confidence numbers were well below even the most pessimistic estimates of market participants. In this environment, incrementalism by the Fed is not an appropriate response. As a result, we expect the FOMC to carry out the ease that is priced into Fed funds futures and lower its target rate to 1% tomorrow.
As noted, that expectation seems borne out by the Cleveland Fed, which calculates the implied probabilities of potential fed funds rates using daily Chicago Board of Trade options contracts:
Regardless of the cut’s actual size, as Deutsche Bank analysts noted on Monday:
… it is becoming apparent that there are also limits to the effect of traditional rate cuts on stimulating the economy.
Which is why even with a 50bp reduction in the target rate, the effective rate (the weighted average of actual, negotiated rates between individual banks) could still see relatively large variations from the target. In fact, if you look at the chart below, from BoA again, you can see the effective rate is already at 1 per cent (again, because of the new Fed policy of paying interest on excess reserves):
That may be why some economists, like former Fed governor Laurence Meyer, are starting to project an eventual target rate of 0 per cent (BoA’s economist says the Fed could lower to at least 0.75 per cent before the bottoming of the cycle). All of which brings us back to that DB point above.
With the effective rate already at 1 per cent (as above) the “easing” has already come through, and the credit market is barely showing signs of recovery. Hence our favourite quote of the day, from Robert Brusca, chief economist at FAO, who notes that in this environment…
Banks are like roach motels. The rate cuts go in but they don’t come out.
Indeed.
Incidentally, Japan is also expected to cut rates imminently: rumours have been circulating that the country’s central bank will follow the Fed’s lead. Roach motel in Japanese is “gokiburi hoi hoi.”
Related links:
Ex-Fed governor makes case for zero fed-funds rate - WSJ Real Time Economics
US rate cut likely, despite scepticism - FT
The unthinkable - FT Alphaville
