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Federal Reserve Cuts 50bp, Dollar Tanks, More Rate Cuts to Come
Wednesday, 30 January 2008 18:35:43 GMT  |  Kathy Lien, Chief Strategist
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The Federal Reserve wants to be ahead of the curve.  They no longer want to be criticized for doing too little, too late and for that reason, they cut interest rates by 50bp today to 3.00 percent.  In a little more than week, the Federal Reserve has lowered interest rates by a total of 125bp, which is more than all of the rates cuts that they made last year combined. 

They are still worried about financial market conditions, tight credit, the stability of the labor market and a further contraction in housing.  Although they believe that their efforts thus far will offset some of the downside risks to growth, the tone of the FOMC statement indicates that this rate cut will not be their last.  Inflation is not a problem at the moment; they expect it to moderate in the coming quarters. 

The rate decision has pushed the US dollar lower against every major currency as it quickly becomes a carry trade funding currency.  A little more than 5 months ago, US interest rates were the fourth highest in the developed world and now it is the third lowest. If you want to understand the price action post FOMC, just take a look at the following table. The US dollar now offers a yield that is 100bp less than Canada and 525bp less than New Zealand.  It is yielding only 25bp more than Switzerland which means that once the Fed lowers rates again in March, and we expect them to, the US dollar will be tied with the Franc as second lowest yielding currency in the developed world.  

 
Before this easing cycle is over, we expect the Federal Reserve to bring US interest rates down to at least 2.50 percent.  If the economy does not improve, interest rates could realistically return to 1.00 percent.  As a result, the US dollar will not escape further weakness. 

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Comparing the FOMC statements **New Language Highlighted

 January 30, 2008 

 The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 3 percent.

 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.

 Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred no change in the target for the federal funds rate at this meeting.

 

January 22, 2008

 
The Federal Open Market Committee has decided to lower its target for the federal funds rate 75 basis points to 3-1/2 percent.

 The Committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth.  While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households.  Moreover, incoming 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.

 Appreciable 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.

 
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Eric S. Rosengren; and Kevin M. Warsh.  Voting against was William Poole, who did not believe that current conditions justified policy action before the regularly scheduled meeting next week. Absent and not voting was Frederic S. Mishkin.

 

By Kathy Lien, Chief Strategist of DailyFX.com

 

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