Will the Fed cut rates?

The market certainly seems to think so.

Just look at interest rate futures and you’ll see investors are expecting a 25 to 50 basis point cut in the Fed Funds Rate.

Or, more meaningfully, look at the gold market. Gold prices spiked to over $785 an ounce, today.

That’s up 17% over the last month and 31% over the last year.

Why does the gold market indicate a cut in the Fed Funds Rate?

Because the Fed does not create growth–they do not possess some magical fairy dust that makes the economy run faster.

The Fed prints money to decrease interest rates. And, when the Fed prints money more quickly than the economy grows, they create inflation.

Gold prices are going up because gold investors believe the Fed will print money, also known as cutting the Fed Funds rate, thus creating inflation.

Gold is going up because investors are guessing the Fed will create inflation by cutting rates.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The Fed’s interest rate cut hurts the prudent

For those who think the Fed’s recent interest rate cut is an unmitigated good, read Allan Sloan’s recent Fortune article titled, “Heads I Win, Tails I Get Bailed Out; The reckless are getting relief from Bernanke. How does that work?”

I’ve blogged in the past about the moral hazard implicit in the Fed cutting rates. I believe the Fed’s large rate cut encourages imprudent risk taking.

But, I didn’t highlight how the rate cut hurts the prudent, and Allan Sloan does a great job of that. As Sloan puts it, the “recent interest rate cut has done a lot of harm to those of us who’ve managed our finances prudently.”

The Fed cut rates to calm market turbulence, and this was directed to helping the “players in the biggest trouble,” those “who’d taken the biggest fliers in junk mortgages, ultra-risky leveraged buyouts, and other financial esoterica that proved to be malignant.”

But, this rate cut not only helped the imprudent, it hurt the prudent. It hurt “those of us who keep score in dollars and didn’t need to be bailed out” because we are now “less wealthy than we were in terms of anything other than our home currency.”

Why? Because the rate cut “contributed heavily to the dollar’s recent sharp drop in the currency markets…and to the price spike in hard assets like gold, silver, copper, and oil.” In other words, prudent people’s wealth, in terms of dollars, is worth less relative to the things we want to buy with dollars.

Added to this, the rate cut caused long term and fixed mortgage rates up. Once again, this benefits the imprudent who gambled on floating rate loans and punishes the prudent who may be seeking fixed rate loans at what are now higher rates.

Those investors who stayed away from toxic waste and invested prudently are also being punished because the Fed’s bailout is helping toxic waste investors to the relative detriment of those who avoided subprime mortgage risks of all sorts (whether bonds, CDO’s, stocks, swaps, etc.).

Finally, the prudent get to bail out the imprudent in that our tax dollars will be used to bail out subprime borrowers, subprime lenders (like Countrywide), subprime investors, and the investment banks and rating agencies who should have known that subprime investments were junk.

As Sloan puts it, the Fed’s bailout allows the imprudent to play “heads I win, tails I get bailed out” whereas prudent investors get stuck with depreciated wealth, higher fixed rate loans, worse relative investment performance, and a higher tax burden.

If you’ve been imprudent over the last several years, you probably think the Fed’s rate cut is wonderful. But, for those of us who were prudent enough to avoid bad risks, the Fed’s rate cut is bad news.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Is the Fed cutting interest rates really a good thing?

It seems like market participants have been wishing, hoping and praying that the Fed will cut interest rates for over a year now. Unfortunately, this may not be a good sign for the market, but a clear signal of worse things to come.

You see, the Fed cuts interest rates not because things are going great, but because they are seeing clear signals the economy is headed for rough waters.

In fact, the stock market has historically dropped around 40% during an average recession, so the Fed cutting interest rates may not be a signal market participants should be cheering about.

Two weeks ago, John Hussman had a brief section on this subject in his weekly Market Comment. He posted a couple of graphs showing how the S&P 500 did during Fed rates cuts that led up to the 2000-2001 and 1981-1982 recessions.

From 2000-2001, the Fed cut interest rates from 6.5% to 1.25%, and yet the S&P 500 tanked around 41.1% over that same period.

From 1981-1982, the Fed cut rates from 20% down to 11%, and yet the S&P 500 tanked around 21.5%.

The Fed cutting interest rates is not a cure-all that makes the market go up. The market does sometime do well because of rate cuts, but not every time.

So, if you’ve been betting on the Fed cutting interest rates in hopes of making a killing in the stock market, you may want to consider buying short term bonds instead–they will much more likely benefit.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.