| Fed Rate Cut : On this page on Monday, we argued that it was too early to rule out an intermeeting rate cut, but that it had to come soon or else we would be waiting until the May 15 meeting. Just when we were about to give up (and poor Wayne Angell already had given up!), the Fed finally came through. As we argued on Monday, the case for a rate cut was compelling. Nonfarm payrolls fell in March, jobless claims have been on the rise, ex-auto retail sales fell for a second straight month, and consumer confidence is still falling. All of these indicators fit in with our view that business investment is leading this downturn, and that the consumer comes next. After excessive investment during the bubble, investment is now falling dramatically. Since businesses cannot simply unload excess capital equipment, they cut costs by unloading workers. That in turn reduces income, confidence, and finally consumer spending. The Fed has finally recognized the nature of this downturn. In past announcements, they have focussed primarily on the inventory correction, and suggested that it would probably not last long. But today, they acknowledged the importance of investment, noting that "capital investment has continued to soften and the persistent erosion in current and expected profitability, in combination with rising uncertainty about the business outlook, seems poised to dampen capital spending going forward." Precisely. Everyone today seems to be wondering what the Fed is seeing that they aren't. We would argue that the Fed is seeing three primary factors. 1) They are understanding that this is not just an inventory correction; it is an investment-led downturn, and it will take time and lower rates to bring to a close. 2) Weakness is now spreading to Europe and Asia, which will further undermine corporate profits and thus investment. 3) The level of real interest rates was still restrictive. The market has placed far too much weight on recent Fed official comments. Fed officials always talk an optimistic game in public and voice their true fears behind closed doors. Those three points are what is being talked about by the Fed in private, and they drove today's decision. More is on the way -- look for another 50 bp cut on May 15, and expect this cycle to take rates below 4% this summer as the economy will continue to struggle. Business investment was the first economic shoe to drop; consumer spending is next. - Greg Jones, Briefing.com |
