To: John Pitera who wrote (4550 ) 8/31/2001 8:49:07 AM From: John Pitera Respond to 3.5% Funds; Where Does It End?risk assessment held to economic weakness as it has since December . The new 3.50% funds rate is the lowest since April 1994 as the Fed began tightening after spending a year and a half at a 3% nominal rate and a negative real (inflation adjusted) policy rate. 11 (there was a hold out) look for further ease through year end with one Dealer looking for funds to stand at 2.75% on Dec 31 -- 25 bp eases at each of the year's remaining meetings. manufacturing sector which is in deep recession as the fever gradually spreads to the transportation and service sectors . Lower energy costs will help at the margin (if sustained) but don't alter the broader view of business cost cutting amid a profit recession and consumers (spending) increasingly injured by layoffs, reduced income and continued equity losses. The Fed held to a 3% nominal funds rate following the early '90s recession given the slightly sub-0% real funds rate . A negative real return on lending turns the lending spigots off and worsens the situation . More importantly, a 0% real funds rate leaves monetary policy without much punch so the Fed won't rush to get there . Textbooks argue that when financial investment alternatives offer such low rates, capital goods receive the investment inflow. However, the current excess capacity argues very strongly against that rationale -- inviting investment abroad and a sharp decline in the dollar value . The final straw, of sorts, for the Fed.Greenspan prefers the PCE inflation measures the Fed now targets leaving a lower 2% nominal funds rate consistent with a 0% real policy rate. Let's call a 2.75% nominal funds rate the low ball estimate if the Fed continues to ease in waiting for the recovery. A lower rate is the pessimistic scenario if the credit constriction turns in to a crunch. We suspect the Fed won't have to move below 3% given the benefit of fortunately timed fiscal stimulus.
