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.
Follow
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Danielle,
In a time when currencies can rise and fall 10% in a matter of a weeks, where is a safe and stable place a person can park their money? It has gotten so utterly ridiculous, that a person could go on a vacation, come back and find out that the currency they are in has fallen by 20%. I really don't understand how businesses, world trade etc can function with such volatility in currencies and commodities. Either we should resort back to gold or come up with a world currency!
A world currency is not a bad idea. It would sure solve a ton of problems.
Wow, a world currency… We have an example of how that might work in present day united Europe. As the financial contagion spreads throughout the region the weakness of the system is slowly being revealed. That not withstanding should a world currency become a reality at some point in distant future (this may very well be the end game in all this mess) I wonder how and who would be responsible for administering and enforcing some kind of consistent monetary policy. Or are you proposing a world government?
Marcus
USD is the world's reserve currency and these kind of surreal movements in my opinion undermine the entire financial system. There is just no way to price things when the underlying currency with which everything is priced them is fluctuating wildly.
US $ is the reserve currency but this state of affairs, in historical terms, exists since yesterday. With a strong push from various parts of the world to price commodities, namely energy, in other coinage (Saddam’s real attempt at a WMD) this status may soon change. World’s strongest currencies have always been the ones backed by the strongest military. Since the States’ recent adventures revealed a few inadequacies, other candidates have been emboldened to challenge the current status of greenbuck. If successful, such turn of events would be detrimental to those of us who, by birthright or choice, reside in North America. It is one thing to see my net worth shrink by 20 percent due to monetary devaluation, another to leave my children to the tender mercies of a new world order in which Canada, a raw material exporter with a valiant but miniscule military, might be seen as a third rate colony.
Marcus
M, if you pay all your expenses in U$, then you should not lose a lot of sleep over relative currency to other countries. It is the standard of living you can buy at home that matters most. D
With the fed funds rate at 1%, possibly reduced to .5% in Dec. then perhaps .25 or 0.0, Danielle, if this scenerio happens, do you think that would be an excellent time to short bonds, as they cannot be priced higher, only lower as interest rates can only move higher.
Thanks. Jimbo
I think shorting bonds is a concept best reserved for only brave souls that specialize in it. D
Hi Danielle,
I wonder if shorting bonds isn't such a bad idea. What if we are seeing a bottom in yields and conversely a top in value?
I have been reading Martin Pring's book “the investors guide to active asset allocation” which seems to mesh quite well with your philosophy of investing in etf's and trying to avoid the buy and hold mentality. One graph in particular struck a cord that got me to wondering. When one looks at a long term graph of government bonds, there is a long steady uptrend in price and downtrend in yield over the last 20 years. Do you have any insight into what flipped the switch 20 years ago and the reverse 20 some years before that?
Is it possible that the volatility we see in 2008 is another major turning point in which people lose confidence over the long term and thus bond and equities are beginning the next 20 year bear cycle where values stagnate but yields (and interest rates) rise? Would this mean that a loss in risk appetite will reverse relative yields and now average equity dividend yields will exceed bond yields due to the implied risk that comes with holding equities (i.e. a switch in environment from growth to value investing)? This seems to back up what many analysts are saying, although I'm sure one can find ideas to support any argument in such volatile times.
I'm a young investor with a 20+ year outlook ahead of me. Should I ignore the really long term trends and just focus on investing the 4-7 year business cycle? I don't have the time or ability to become a value investor if the growth investing paradigm has run its course.
Sorry for the long winded note, I'd welcome any words of wisdom from someone well studied in historical markets.
Thanks!
Martin
thank you
nice post