U.S. Fed Interest Rate Cut Will Do Little to Stoke Economy

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As the market began to buckle at the knees in late July, certain CNBC commentators and other observers of the financial world began to howl like whipped dogs for a rate cut. Specifically, they wanted the United States Federal Reserve to cut the federal funds rate target, a key interest rate from which many other interest rates take their cue.

The thinking goes that a rate cut would help the stock market and everyone would make money again. Crisis averted. Finger in the dike and all of that. But as financial analyst Michael Belkin recently noted, “The consensus is 100% convinced that the Fed rate cuts are always bullish. But the data say otherwise.”

Ah, the data. Yes, there is the little matter of looking to see what actually happened the last time the Fed began cutting rates. This involves some minimal work. Most of the blowhards on TV would rather stick needles in their eyes or swallow live goldfish. But if you just look at the last set of rate cuts, you dig out a rather stunning picture.

Specifically, during the last United States interest rate cut cycle, the S&P 500 – a common stock market benchmark – fell 47%. From a starting point of 6.5% in January 2001, the Fed cut rates all the way down to 1%. Yet it didn’t seem to help the stock market.

For another example, look at Japan. The Bank of Japan cut rates practically to zero by 1995, yet the Nikkei would still get cut in half after that. Bringing these things up to a central banker is like talking to one of Napoleon’s marshals about the Russian campaign.

What does this mean? It means something painfully obvious: Interest rates aren’t the whole shebang. Other things matter more, such as the price you pay for the stocks you own…And which stocks you own.

Back in 2001, we had the dot-com bubble finally popping. The whole technology, media and telecommunication mania finally ended. According to “Bull: A History of the Boom,” by Maggie Mahar, “By February 2002, 100 million individual investors had lost $5 trillion, or 30% of the wealth they had accumulated in the stock market – just since the spring of 2000.”

As a result of this massive unwinding – which included several big bankruptcies, job losses, etc. – we had a recession. There is debate about when it exactly started and when it exactly ended. Point is this: The U.S. economy did some shrinking during this period.

Today, there is a major crack in the U.S. mortgage markets. Bad bets on mortgage-backed securities have completely wiped out some hedge funds and dealt heavy losses on investors across the spectrum. The mess cleaved deep wounds in the balance sheets of many mortgage lenders, crushing their stock prices and threatening their very existence. The biggest mortgage lender in the U.S., Countrywide, faces possible bankruptcy.

U.S. Housing prices are falling. The 3.2% drop in the second quarter was the steepest rate of decline since Standard & Poor’s began tracking its nationwide housing index in 1987. Inventories are building, too. The U.S. supply of unsold homes recently hit a 16-year high.

So as with the 2001-2003 period, you have a large bubble finally bursting. Hard to imagine that the mega-bust in housing doesn’t at least slow down economic growth or toss us into the winter marsh of a recession. In which case, rate cuts will be like white lace on a coal miner – which is to say, utterly irrelevant, and even a little ridiculous. Short term, interest rate cuts produce a few fleeting stock market rallies, but that’s about it.

I’m not predicting stock prices will fall as dramatically as they did in 2001-2003. Valuations are lower today, generally speaking. And every stock market episode is different. But I do think that you should ignore the Fed. What you own – and the price you pay to own it – will be much more important than anything the Fed does.

After all, some well-placed bets on commodity and housing stocks back in 2000 paid off handsomely only five years later. So there will be flowers in the coal pit for us to pick up today. I’m betting water, energy and infrastructure companies will be among them.

Chris Mayer
for The Daily Reckoning Australia

Chris Mayer
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.
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2 Comments on "U.S. Fed Interest Rate Cut Will Do Little to Stoke Economy"

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Martin
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Funny you mention it, but I’ve had an inkling for a while now that the “Sydney Water Crisis” is a complete scam. I noted from a recent Property Council email newsletter that Sydney Water have put in a submisson to jack up prices over the next few years. Looks like the years of ‘media investment’ will finally begin to pay off, and we repentent water wasting mobs won’t mind a bit. I first got that odd “Hmmm…that aint right” feeling a few years back when the black and yellow “water police” cars started cruisng the streets for some one to… Read more »
Gooby wooby
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If people would just shut the hell up about the housing market, my damn house would sell.

I saw the same thing happen in the UK in 2005. Negative negative negative media talk about the housing market and with that people stopped buying and sat on their asses hoping that the market would fall more so they could get a steal.

I wondered if this all wasn’t intentional. Maybe the rich in the US want to buy up all the worthless housing and put folks on the streets so that they can own the US completely.

wpDiscuz
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