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1:56 pm - Sunday September 25, 2016

The Fool in the Shower – Is the Fed Turning On the Hot Water Full Blast?

| Economics | Rating: 4.5
by Numan

Milton Freedman supposedly made up this analogy describing a bather in cold water who turns on the hot water all the way up and gets scaled.

To be perfectly honest I have no idea how the Fed’s cut in interest rates will affect the markets. I do have a strong intuitive feeling this isn’t over yet.

This interest cut has been the biggest reduction ever, I believe. Furthermore, this has been the first time the Fed has changed the funds rate between meetings since 2001 (combined effects of terrorism attacks and a recession).

On the one hand this immediate response to stock market plunges world wide is admirable and seems attentive and responsive to market needs. On the other side it’s as troubling as the price plunges themselves.

The Fed’s cut is most certainly a clear sign we’re in trouble. The funds rate is the most available and most immediate tool a central bank has. The quick and resolute cut in interest rates sent a message was meant to show worldwide markets someone is still in control. However, as we’ve learned countless times before reversing the trend is never an easy task.

There is something troubling about taking popular, some might say populist, measures such as drastic cut in interest rates. Such a move by a central bank makes me uneasy as central banks are expected to behave responsibly and rationally.

Two factors add to my worries. One is the decision by the head of the European central bank, Jean-Claude Trichet, not to cut rates as Europe still battles inflation. Rate cuts could lead to more volatility in already volatile markets, he added. The second is the fact future contracts predicted an additional 0.5 cut in rates in the Fed’s meeting that was scheduled for the next week. The shows the capital markets are hungry for available cash. Maybe too hungry to consider the consequences of another deep cut in rates in just two weeks.

If the Fed’s decided to cut rates by an additional 0.5% Bernanke has literally used all the artillery he has at his disposal. What would be the next move should the markets insist we’re in a recession? I believe the situation would be even graver.

Apparently there is a lot of criticism by senior economists on Bernanke’s move. The leadership ability of the Fed is criticised and the decision to cut the funds rate by 0.75% is dubbed a panic reaction. The immediateness of the decisions is wondered upon.

Needless to say the Fed’s actions have increased to dollar’s weakness and volatility. The last thing the battered dollar needs right now.

Time will tell if the Fed acted in panic or with courage. I believe we’ll get a chance to answer this question soon enough.

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