The Economy Guy

The FED pulled the trigger, and reduced the Fed Funds rate by 0.50%, reducing the rate to 3.0%.  That puts the prime rate at 6.0%.  It’s been a long time since we had such cheap money.  Nice if you can access it.

The stock market waited for the announcement, then moved up, and abruptly moved down ending off 37 points.

The bond market was more ominous.  The 10 Year Treasury increased to 3.73%.  What this means is the bond maturity curve is “steepening.”  The reason the curve is steepening (short term rates are decreasing, and longer term rates are increasing) is that the ugly word INFLATION is being pooh-poohed by the FED, but not by the bond market.  This is a surprise to me, as I expected the bond market to decrease in the 10 Year Treasury, rather than increase.  Mortgage rates will start up with the 10 Year.  Now 2 days don’t make a market, so the real trend will become more visible over the next week.

The Dollar finally cracked, and the Euro approached its old high.  We’ll see if there is follow through over the next few days, but if there is, the Dollar should fall 2 or 3 cents against the Euro, and all other currencies.

In Today’s News….

The Big News was the 4th Quarter GDP numbers.  It was very bad.  Annualized, the 4th Quarter GDP was 0.6% growth.  That is basically flat – meaning no growth.  By comparison, the 3rd Quarter GDP was 4.9% growth, a very healthy growth.  The entire year (the average of the 4 quarters growth figures) was 2.2% - fairly bad.

If we look a little deeper in this announcement, we’ll see the reasoning behind the Fed reduction in interest rates.  Many news commentaries have criticized the Fed for reducing the Fed Funds rate too late, and too fast (more recently).  However, the FED knew something other people didn’t know.  They knew the economy was really going into a recession.  The difference between 0.6% growth, and zero percent is miniscule.  So, the financial press gurus were wrong again.  Just another lesson not to believe everything you read or hear.

Let’s look at the 0.6% GDP growth figures again.  If you remember, the current inflation rate is 2.7%.  That means that the US economy’s growth is NOT keeping up with inflation.  In fact, this is a negative real growth rate.  Politicians don’t want to highlight this fact, so they won’t.  They might be held responsible.

So, let’s take a look at the current threats to the US economy as we enter February.  First the housing industry is in a freefall.  Secondly, there remains a liquidity problem out there – just try to get a good loan.  Thirdly, the President and US Congress is trying to add $150B to the deficit – admittedly to kick start the economy by getting people to spend their rebate checks immediately.  That $150B increase in our fiscal deficit must be paid back by ourselves, our children and our grandchildren.  In the meantime, more to the point, the foreign holders of our US Treasury Bonds are looking at their investment in US Dollars dwindle.  Their investment is going down because bonds are increasing in interest rates (= decreasing in value) right now, the US Dollar is declining in value against their own currency, and there is a risk that the US government might now be able to pay back their debt without a greater Dollar depreciation.  Why would a foreign nation buy more US Bonds??  Probably because they don’t have a lot of other options.

Here is what the Fed officially said:
“Financial markets remain under considerable stress, and credit has tightened further for some businesses and households.  Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.  The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.  Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity.  However, downside risks to growth remain.  The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.”

The Fed is clearly admitting that the US economy is in a bad position.  The US Bond market has priced in 2 or 3 more 0.25% interest rate reductions later this year.  As I have stated earlier, the Fed is being squeezed between a recession and an inflation.  Their actions are open for criticism, but my own personal opinion is that I don’t know as much as they know regarding the US economy.  Each vote at the Fed is NOT unanimous, meaning the data can be interpreted differently. Hold onto your hats!!!!!!!!

Here are today’s Numbers:
Dow Jones 30 Industrial - 12,443 (Down 37 points)
10 Year Treasury Bond - 3.73% (up $.08)
Euro - $1.4862
Gold - $926 (down $5)
Oil - $91.75 (up $011)
Gasoline - $2.33 (no change)