The Fed decision: It's the economy!

Posted Sep 18th 2007 3:30PM by Douglas S. Roberts
Filed under: Good news, Market Matters, Economic Data, Headline News, Federal Reserve

The Federal Open Market Committee (FOMC) lowered both the Federal Funds Rate and the Discount Rate by 0.50%. This move was designed "to forestall some of the adverse effects on the broader economy" resulting from recent financial market disruptions.

Most people were expecting that both interest rates would only be cut by 0.25%. My forecast had been that the Fed Funds Rate would be cut by 0.25% and the Discount Rate by 0.50%. The market has experienced a rally upon release of the news.

Although the Fed has expressed concern about the moral hazard of a rate cut that rescues financial market participants that assumed too much risk, the rate decision indicates that the economy is its primary concern. As I mentioned in an earlier post, the recent negative unemployment report is the key issue.

The housing crisis is unlikely to improve in the near future. As long as people are employed, I believe that they will struggle to service the debt and try to do whatever is necessary to keep their homes. However, if they lose their jobs, foreclosure could increase substantially.

My belief was that the Fed would try to use the Discount Rate as its preferred method of dealing with the situation. It opted to use the Fed Funds Rate instead. Because of potential ramifications of increased unemployment on the economy, Chairman Bernanke did not want to make a possible mistake that could cause a recession. The PPI numbers also came in better than expected which allowed the Fed to lower rates without appearing soft on inflation.

In the battle between forestalling a recession and preventing a moral hazard, the Fed correctly chose the economy as the greater priority. Hopefully, it will take other steps to deal with the moral hazard issue.

Whatever your opinion, the Fed has made its decision. It is important to realize that the Fed has clearly indicated that it will do whatever is necessary to prevent a recession. This is why it is more important and profitable to Follow the Fed's actions instead of trying to predict them.

Doug Roberts is the Founder and Chief Investment Strategist for FollowtheFed.com,

Tags: Ben Bernanke, BenBernanke, featured, Federal Open Market Committee, Federal Reserve, FederalOpenMarketCommittee, FederalReserve, Interest rate cut, InterestRateCut, The Fed, TheFed