We are living in remarkable times. History is being made every day in every way.
This afternoon, the US Federal Reserve cut the benchmark rate by .50% to 1%. Again. This is the second time they have cuts rates this low in our life time. The last historic occasion was in June 2003, when the Feds announced “emergency measures” in a “temporary” effort to jump start consumption following the 2001 shallow, short recession.
But that was then, and this is now. And the world economies are in a lot worse shape now compared with 2003. Back then we just had a stock market bubble and the after shocks of 9/11 to deal with. By the time the Fed cut to 1% in 2003, the economy had already pulled out of the 2001 recession. Today we are maybe half way through a 2 year long recession. Today the world is reeling from imploding real estate, a credit crunch and decimated financial markets. People are truly feeling this financial affront from all possible sides.
A .50% cut was what I expected at this point. Inflation has fallen as of late. We are potentially facing a period of overall deflation, at least in the near term. After that it’s anyone's guess from here- one can argue present monetary policy will trigger inflation down the road.
But today demand has fallen off a cliff. The world is up to its nose in one of the worst global downturns in human history. Of course the Fed wanted to cut rates. But as I look at the world today I doubt that this 1% will have the same simulative effect as the last 1% did in 2003.
First of all, the cut to 1% in 2003 did not work right away even then. They left rates at 1% for one full year before consumption picked up meaningfully in 2004.
Secondly, consumers also had a lot less debt in 2003 than they do today. People even had some savings back then. Today people have already over-borrowed and over-spent. They are done, full– caught their limit. The obsession now is to get debt off their backs. Consumers don’t want more; they now want a whole lot less.
The other elephant in the room of course, is that there are only 4 x -.25 bullets left in this Fed’s gun. They can’t cut lower than 0%. At 1%, rates are already way below inflation. Rates have been negative in real terms for some time now. Rates have clearly not mattered a wit; demand has evaporated all the same.
We also have Japan as a precedent for zero policy rates. A quarter century later, the Japanese economy is still struggling to recover meaningful growth.
We will watch with hope, but guard our capital carefully.
Cory’s Chart Corner
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