Media Hops on 'Rate Cut' Wagon

A: Last post, I promise. Also, I will get back to posting on Manhattan real estate when I get back to work after my vacation; I needed some time of from real estate after sealing all my deals and selling my exclusive listings. So, don't worry to those who were disappointed with the main focus being on the credit crisis, process of deleveraging, bailouts, etc..There is a reason I talk about that stuff here, and its because it is so damn important!

I've been dovish on future monetary policy for many months now, even after the aggressive rate cutting campaign by our federal reserve to forestall adverse economic effects and the credit crisis. The main reason is that the biggest threat to our economy is deflation, not inflation. A powerful combination of housing deflation & credit deflation, among other things, resulted in a seizing up of the secondary mortgage markets causing sooooo much pain for those holding assets tied to mortgages. One of the end results of all this was the extinction of MEW, or Mortgage Equity Withdrawal, as a growth driver for our economy. I discussed MEW back in June:

"When I see reports that mortgage equity withdrawal (MEW) is down 60% from Q1 2007, courtesy of Calculated Risk, I see the credit machine for growth broken. MEW is that little thing homeowners do to pull out money from their homes equity and spend it; so yes, down 60% year-over-year is noteworthy."

Yea, we don't hear about homeowners pulling out equity from their homes anymore to pay down other debts, or to spend! And with house prices way down, and loan-to-value ratios way UP as a result, most banks won't allow you to pull out equity anymore if it's too risky for them. Besides, most banks are fighting to repair their balance sheets right now and forced to raise dilutive capital. The process will continue and we are YET TO SEE THE MAIN STREET ECONOMIC AFTER-EFFECTS of credit deflation!

As unemployment rises, wages stagnate, credit contracts, houses deflate, and shadow banking system continues to see major losses, the fed is going to have to be stimulative. Think of it this way, at some point unemployment is likely to rise above 6.5% and GDP will go negative, whether in a preliminary report or in a backward revision. Either way, we will probably hear calls from the fed to cut rates to stimulate and inflate. The full effect of this 13 month long CREDIT TSUNAMI is yet to come on main street.

From CNN Money's article, "Fed's next move could be to lower rates":

The central bank is likely to keep its key interest rate at 2% at its September 16 meeting but expectations are growing for a rate cut before year's end. If the Fed does so, it would mark a dramatic change in the central bank's assessment of the economy. As recently as the Fed's last meeting in August, Fed members indicated that their next move would be to hike rates at some undetermined point in the future in order to fight inflation.

With the commodity bubble bursting, inflation expectations are likely to fall significantly in coming reports. But that doesn't really matter because the type of inflation that usually spurs aggressive rate hikes, is wage inflation and an expansion of the money supply/credit. We have neither, and instead, are experiencing stagnating wages and a contraction of credit. As commodities fall, the fed's ability to cut rates to battle the economic after effects becomes OK again.

Its a dose of tough medicine for an economy BUILT ON CREDIT! Ain't deleveraging a bitch! I would not be surprised to see fed funds rate go to 1% to 1.5% in the next 6-8 months. I am going to stand by my gut feeling that the first rate cut will likely be in response to a very negative event, such as a failure of a major IB or bank. Clearly, Lehman & Washington Mutual top the list as of today, and with the Fannie/Freddie bailout behind us, I seriously doubt the fed/treasury will come in and save the day again for wall street bigs. Moral hazard is already a very serious problem and at some point, they will have to let the free markets, or what used to be the free markets, take care of themselves.

Enjoy all!

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