At least the Fed didn’t blow it. The FOMC‘s 50 basis point rate cut yesterday gave the markets just enough oxygen to keep breathing until further evidence of a deteriorating economy necessitates the next rate cut. It could have been worse. And based on the fact that all the markets were virtually unchanged yesterday, it wasn’t a surprise.
In the statement that accompanied the FOMC’s decision, there was nothing explicit to conclusively enshrine the “one and done” argument that has led to a crash in the long bond over the last three weeks. But so far that sentiment — which holds that this would be the last rate cut — continues to prevail, because there was nothing in the statement to refute it, either. The big Wall Street investment banks’ flash analyses distributed to institutional clients immediately following the FOMC meeting reflect only limited optimism that rate cuts will continue.
Merrill Lynch told clients, “We think another easing is likely at the next FOMC meeting on June 27 however, we think it is also likely the Fed will move to smaller increments, 25bp, although this depends upon the kind of economic data that is released between now and then. As we have previously said, we think the Fed Funds rate will be at 3.5% by the end of August.”
Goldman Sachs wrote, “We retain the view that another 50 bp is likely before end of summer; whether at next meeting remains to be seen.”
Credit Suisse First Boston wrote, “The funds rate has fallen by a cumulative 250bps so far this year. It’s time for the Fed to take a breather.”
And Morgan Stanley wrote, “In the end, their options remain open and they can respond to the incoming data flow as appropriate. We continue to look for a 3.75% trough on the funds rate implying some slight further easing — probably at the August meeting.”
Since the announcement I’ve gotten several emails asking me why only a handful of regional Federal Reserve Banks requested a cut in the discount rate this time around, as opposed to the unanimous requests that had accompanied the previous cuts this year.
My favorite Fed guru, MetaMarkets Think Tank member David Gitlitz, now Managing Director and Senior Economist at Kudlow & Company, told me not to be worried about it. According to Gitlitz, “It’s pretty much a formality. They all knew they would be cutting rates today, so it doesn’t really matter whether all 12 request the discount rate move. It could be that earlier in the process Greenspan wanted to convey some sense of urgency with a unanimous request.”
For me the only upbeat element of the FOMC’s statement was the appearance of the first explicit reference to inflation since the January 31 statement: “With pressures on labor and product markets easing, inflation is expected to remain contained.” This seems to be directed explicitly at concerns that have evolved since the Fed’s last surprise rate cut that a headlong easing process would inevitably lead to a resurgence of inflation.
So at the end of the day I remain convinced that nothing but the most aggressive, immediate and persistent easing by the Fed will do. And I remain concerned that cutting rates isn’t even an effective way to ease – if by “ease” we mean printing more money to halt the persistent deflationary spiral induced by the Fed’s previously too-tight policies. While the various “M” measurements have grown rapidly this year, the Fed’s balance sheet has shown no net growth this year, and the adjusted monetary base has been declining at an annual rate of about 1% over the past three months.
It’s easy to say “don’t fight the Fed.” But consider what the Fed itself has to fight. We are in a post-boom-and-bust economy in which unprecedented inventory and debt adjustments still remain to be accomplished, in which risk aversion is abnormally high, and in which returns on capital investments are abnormally low.
That’s a world of deflation and default in which cash in king. Only the Fed can dethrone cash — and the only way to do that is to print more of it than people want. That’s not going to happen with the kind of rate cuts the market is now forecasting.
The markets are now in a dangerous consolidation after their big run-ups since late March and early April. So many people are so totally hypnotized by the “don’t fight the Fed” mantra that it wouldn’t surprise me to see a brief rally here, back toward the highs achieved two weeks ago. Maybe a narrow defensive index like the Dow Jones Industrial Average might even make new recovery highs — briefly. But it won’t last.
If “one and done” is the deal, then what’s done is this rally. Because we’re back in a world where only strong evidence of economic deterioration will get the Fed to do the right thing and keep easing.
This is still a bear market rally, folks.
