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The Fed’s quarter-point rate cut — just announced two hours ago — is a huge disappointment to U.S. stock investors … but a great bonanza for the Japanese yen!
Reasons:
U.S. stock investors were hoping for a half-point cut — if not in the fed funds rate, then at least in the discount rate.
They got neither. So now their hopes are dashed, and they’re frightened of the consequences.
The Japanese yen, meanwhile, is the paramount destination for scared money. So in response to the disappointing rate cuts, frightened investors are flocking to the yen and driving its value up against the dollar.
This is exactly what our currency expert Jack Crooks told you would happen. Now it’s happening.
Too Little, Too Late
For the U.S. Economy
Meanwhile, the U.S. economy is being dragged down by the housing bust, the mortgage meltdown and the spreading credit crunch.
And today’s meager quarter-point cut in rates will barely make a dent in this mess.
What does the Fed have to say about the crisis? Not much, except to acknowledge they’re confused and they’ll let us know what they think at some later date.
Not exactly reassuring to a market that was looking for leadership!
The Big Shocker
Now, here’s what Wall Street has not yet figured out …
Despite all the Fed’s rate cutting over the past few months, the key interest rate the Fed does not control — the London Interbank Offered Rate (LIBOR) — is striking out on a different path.
Many years ago, this might not have mattered very much. LIBOR was largely irrelevant to American borrowers.
No more!
Today, LIBOR is the rate that drives most adjustable rate mortgages in the United States.
LIBOR is the rate that sets the standard for many corporate loans, a big chunk of the interbank borrowing by U.S. banks, even local government borrowing.
LIBOR is easily the single most important interest rate in the world.
But LIBOR is not controlled by the Federal Reserve. It’s the rate international banks charge each other on short-term loans.
Those banks don’t know where the bodies lie or who’s going to be the next victim of the subprime disaster. So no matter what the Fed does or says, they’re hoarding their capital. And they’re not cutting their rates.
Here’s the key:
Even if the Fed lowered its target for fed funds to zero … if the LIBOR rate fails to decline in tandem, or worse, actually goes up, the Fed’s power to avert an economic decline in the U.S. will be shot to pieces.
And that’s exactly what’s beginning to happening:
Until August, the LIBOR market was mostly in lock step with our fed funds rate.
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But then, when the subprime crisis burst onto the scene … confidence shifted to fear … the shift hit the fan … and the LIBOR rate surged.
Despite the Fed’s efforts to calm the crisis, the LIBOR market has slashed its umbilical cord to Fed-controlled interest rates … broken off on a different path … and set the stage for one of the greatest financial battles of the century.
This chart, showing the spread between the LIBOR rate and the fed funds rate, is the proof. This spread was virtually flat until the summer. Then it went berserk to the upside and has been on its own orbit ever since.
Bottom line: The Fed’s .25% rate cut today is no longer the big issue.
The big issue is:
- What will happen in the LIBOR market tomorrow morning and in the days to come? And …
- If the LIBOR rate continues on its own, separate path, how will that impact the U.S. economy, where so much borrowing is tied directly to LIBOR?
Our answer:
A U.S. recession is written in stone …
Best wishes,
Martin and Mike
About Money and Markets
For more information and archived issues, visit http://www.moneyandmarkets.com
Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, Tony Sagami, and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Amber Dakar, Adam Shafer, Andrea Baumwald, Kristen Adams, Maryellen Murphy, Red Morgan, Jennifer Newman-Amos, Julie Trudeau, and Dinesh Kalera.
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