Fed Ignores Dollar, Slashes Rates Again

A cut of three-quarters of a percentage point in the federal funds rate to 2.25% creates a fascinating financial drama.

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Interesting post-rate-cut comments on CNBC by bond gurus Bill Gross of PIMCO and Ken Volpert of Vanguard. Both guys said they were way more worried about deflation than inflation—despite high gold, oil, and food prices. Probably the Federal Open Market Committee is, too—at least that seems to be the view of economist Drew Matus over at Lehman Brothers:

The FOMC noted that the rate cut today, in addition to other measures taken—nonmonetary policy actions—should "promote moderate growth over time." This allusion confirms our view that the Fed is conducting a two-pronged approach to policy with non rate measures designed to open the credit channels to allow the Fed funds rate cuts to have their full effect. We expect the Fed to continue this approach and look for the Fed to consider additional options to re-open credit channels while also continuing to cut interest rates. We continue to expect the Fed to cut rates by 50 basis points in both April and June, taking the Fed funds rate to 1.25% by mid-year.

Brian Bethune at Global Insight also sees the Fed going below the 2 percent level:

Even with this action, however, near-term cyclical risks to the economy remain elevated—the FOMC acknowledged this in its press statement, noting once again that downside risks remain. With downside risks to growth remaining the dominant concern over the next several months, Global Insight is forecasting that the Federal Reserve will move to lower rates over the next two meetings by a further 75 basis points, thereby taking the federal funds rate down to 1.50% by the summer period.

Same goes for the folks at Action Economics:

We will assume that the Fed cuts the target by a half point one last time in this cycle to 1.75% in April, while continuing to expand its alphabet soup of creative and targeted liquidity solutions to avoid further solvency problems in the banking sector. As the pendulum swings toward the end-point in the easing cycle, the Fed will have to be increasingly careful not to use up its ammunition and risk stoking the confidence crisis, undermining the dollar, and destabilizing inflation expectations.

My take: I love that comment by Action Economics about the risk of "undermining the dollar." I am pretty sure global confidence in the greenback has already been undermined to some extent, as evidenced not only by its plunge vs. the euro and yen but also by the rise in oil prices. But apparently the Fed is taking the approach that says if your house on fire, you worry about the cracks in the foundation later. In other words, healing the credit markets and preventing a nasty recession are what's needed now, and doing that will eventually lead to a stronger dollar. With the Dow up more than 400 points today, it's hard to argue with the logic—for now.