InvestorsHub Logo
Followers 59
Posts 7680
Boards Moderated 1
Alias Born 12/22/2005

Re: None

Wednesday, 12/10/2008 3:08:47 PM

Wednesday, December 10, 2008 3:08:47 PM

Post# of 796067
Fed to cut rates again, maybe all the way to zero
More aggressive 'nontraditional' policy means also in store

12/10 12:01 PM
WASHINGTON (MarketWatch) -- The Federal Reserve is expected to cut rates again at the end of a two-day policy meeting next Tuesday and could be on the road to zero.
"Our view is that the Fed will continue pulling out all the stops" to fight the downturn, said Jonathan Basile, an economist at Credit Suisse Holdings Inc.
At the moment, the federal funds rate stands at 1%. Since October, the Fed has slashed target lending rates by 50%. That followed a series of earlier rate cuts that brought the funds rate down from 5.25% in September 2007.
Economic weakness is now feeding on itself, creating a more severe downturn, and hope that the economy will rebound in the second half of 2009 is quickly fading.
In a key speech on Dec. 1, Fed chief Ben Bernanke promised vigorous action to combat the downturn.
For Fed watchers, "vigorous" action translates into policy actions that include cutting the funds rate to the lowest feasible level and more "nontraditional" steps like buying more debt to lower interest rates and unclog markets.
Analysts believe it means a minimum cut on Dec. 16 of a half-a percentage point to 0.5%.
Economists at the top government dealers agree with the half-point call.
"One has to assume [the Federal Open Market Committee] is going to cut rates by 50 basis points. They have been talking about the fact they can do more -- I don't see why they shouldn't," said Bill Cheney, chief economist at John Hancock Financial in Boston. "Anything less will be viewed as inadequate."
There is a lively debate about whether the Fed would stop after a half-point cut.
Right now, just seven economists at the 16 primary dealer firms are on record as believing the Fed will go below 0.5%. Three dealers put the endpoint as zero. So the majority don't believe the Fed wants to go all the way to zero.
'Considerable period'?
During the last cycle, when the Fed brought the funds rate down to 1%, the central bank adopted language to signal that rates were going to stay low. The Fed accomplished this by saying that it intended to keep rates low for a "considerable period."
This wording lasted in Fed statements from 2003 until 2005.
Some economists today expect a reprise, with similar language acting as a signal to the market that rates are going to stay low for some time.
"The Fed may be very close to making a conditional commitment to keep rates low as long as needed to restore financial stability and to bring about economic recovery," wrote the economic team at Citigroup. It would help ward off the risk of deflation, they argued.
But other Fed watchers disagree.
Brian Sack, a former Fed staffer who is now at Macroeconomic Advisors, said the "considerable period" language is controversial. Many have argued that the Fed kept rates too low for too long early this decade and that the language was part of that problem.
Some economists believe the policy statement will have to communicate the Fed's thinking clearly.
"It is important how they describe what they plan to do going forward," said Geoffrey Somes, a senior economist at State Street Global Advisors.
There is a sense in the markets that the government's response to the crisis has been "ad hoc," Somes said. "Markets would be more comfortable and investors would have more confidence if they understood a comprehensive strategy - that is the real challenge for the Fed."
Basile of Credit Suisse agreed: "They are going to have to spell out what they are going to do next and how they are going to do it."
Sideshow?
A further cut in the funds rate is already a bit of a sideshow, economists admit.
Short-term rates have routinely fallen below the Fed's target level since the last Fed cut in October. So rates are already very low. Getting rates to zero doesn't mean the central bank is powerless, analysts said. It simply would need to change tactics.
"It doesn't mean that they will be sitting on the sidelines," said Somes.
A key upcoming action could be the "quantitative easing," via nontraditional approaches, of monetary policy. The Fed has already engaged in a bit of quantitative easing, although the central bank typically shies away from the term itself.
In essence, the Fed is putting massive amounts of reserves into the banking system above and beyond what is normally needed for day-to-day business.
Open-market purchases of Treasurys would lead to lower yields, and the central bank could also buy other debt to raise their prices.
"The goal would be to lower long-term rates and help underpin spending and risk taking," the Citigroup team said.
The Fed has just begun buying mortgage securities sponsored by Fannie Mae (FNM:$0.7094,$-0.0806,-10.20%) and Freddie Mac (FRE:$0.74,00$-0.05,00-6.33%) . The program has been called a success because it led to dropping mortgages rates and a bout of refinancing by homeowners.
Economists widely expect more aggressive quantitative-easing measures. Goldman Sachs and other economists expect the Fed to expand its purchases in size and breadth of asset classes. This includes nonagency mortgage-backed securities, commercial-mortgage-backed securities and even bulk unsecuritized mortgages.
The Fed is getting set to launch a new facility to supporting the issuance of asset-backed securities collateralized by student loans, auto loans, credit card loans and loans guaranteed by the Small Business Administration.
Economists admit that the consequences of the new policy stance are unpredictable. They also say that the Fed may find that it's easy to launch these efforts but difficult to devise an exit strategy.
But the focus now must be on the worsening downturn, economists agree. They hope that Fed policy, when combined with an aggressive stimulus plan by President-elect Barack Obama, will break the back of the recession.