Speaking of currency, the US Federal Reserve announces its rate policy decision later this evening Aussie time. Here’s our prediction: a cut of 50 basis points in the funds rate (the rate at which banks lend to one another) and a cut of 50 basis points in the discount rate (the rate at which the Fed lends to banks). It will look either like a total panic or decisive leadership, depending on your perspective.
It’s an ambitious forecast. But in addition to facing rising oil prices, the Fed faces a recession. Americans are only now starting to see how much the housing bubble boosted employment (construction, mortgage brokers, real estate, DIY home hardware) and consumer spending (cash-out refinancing and home equity lines of credit). Without that stimulus to employment and consumer spending, the economy won’t just grow less fast. It will shrink some.
And what about the politics of a rate cut? In the current political environment, the Fed will act to boost employment and housing at the expense of a stable currency. This could be very bad news for the dollar. But on the verge of an election year in the States, and under a growing drumbeat of stories about foreclosed homeowners and victims of predatory lending, the Fed has about one good chance to shift the public mood.
And make no mistake, a double-barrelled rate cut is about reversing the bear market in trust and confidence that’s gripping both institutions and the global public. The continued bank run at Northern Rock in Britain has got to be on the Fed’s mind. It needs to stop the negative sentiment dead in its tracks – or risk being overrun by it.
Though a similar panic hasn’t taken place in the States, the Fed understands that the source of the dollar’s remaining strength is one thing and one thing only: confidence. If that confidence is lost, so is the ability of the Fed to manage the situation (and that’s pretty sketchy as it is).
Will a rate cut do anything to solve the underlying problems? Not that we can see. Wall Street is spoiled. It wants free money. The Fed enables America’s addition to cheap money. Withdrawal is painful. But it’s the only way to better economic health.
The Daily Reckoning Australia