The compelling question, following the U.S. Federal Reserve's 125-basis-point cut in short-term interest rates in 8 days, is whether the Fed has done enough."Probably not," economist David H. Wang told BloggingStocks Thursday. "But they've done all they can do, politically and practically, until the next meeting in five or so weeks."
By practically, Wang means that barring another market plunge or a capitulation day, the Fed is not prepared to lower rates before its next meeting. The Fed is already facing criticism that it responded earlier not to economic conditions, but to Wall Street's demands -- perpetual demands in the view of some -- for interest rate cuts. In this climate it would take an extraordinary event to secure another Fed emergency cut, he said.
By politically, Wang means the Fed is, similarly, facing criticism that its current easing policy will increase inflation pressure. "Some in Washington believe in inflation will accelerate so much that by year's end the Fed may be forced to raise rates. And I grant you, it's not a baseless concern," Wang said.
Hence, given the above context investors, readers should not 'count on' another 50-basis-point interest rate cut when the Fed meets next, Wang said. But another 25-basis-point cut, assuming a likely, continued, sluggish U.S. economic fundamentals, would be "reasonable and consistent" with the Fed's accommodative policy to get the U.S. economy growth again. Inflation, Wang notes, is already above the Fed's 1.7-1.9% comfort zone, but holding inflation to that range will have to be sacrificed to address a greater concern: a potentially large recession.
An old friend: term auction facility
Economist Steve Affinito said Thursday that Wall Street and the markets tend to fixate on whatever is troubling investors presently -- Wall Street's "obsession of the moment" is how he phrased it. It's an outlook that places an inordinate concern on short-term goals, and often loses sight of a problem's complexity and its accompanying long-term solutions, he said. In this case, Affinito said, Wall Street is fixated on interest rates, and forgotten about an old friend -- an old friend just created in the fall: the Fed's term auction facility.
"We've seen few news stories lately about the term auction facility but this instrument will continue to play a pivotal role as the United States deals with the housing recession and the subprime mortgage default issue," Affinito said. "The Fed will point to the TAF [term auction facility] for those banks that have short-term liquidity needs. And there most likely will be substantial consolidation in the banking and mortgage lender segments, but that's part of the recovery process. No additional interest rate cuts will stop that."
An even older friend: U.S. Congress
Further, in addition to an accommodative interest rate policy and the term auction facility, Affinito said Wall Street has forgotten about an even older friend -- one that will play just as important a role in any U.S. economic recovery: the U.S. Congress. Affinito said the proposed $150 billion fiscal stimulus package that's winding its way through Congress to President Bush's desk speaks to both the seriousness of the current U.S. economic slump and its complex solution.
"Rate cuts and the term auction facility address short-term liquidity needs, and also encourage lending and investment. Fiscal stimulus addresses longer-term stimulus, 6-12 months out," Affinito said. "The tax rebates will provide some economic stimulus, but they're by no means a cure-all, but they will increase GDP and commercial activity."
Beyond that, Wang and Affinito agreed that the U.S. will need a solution to any liquidity/solvency concerns relating to bond insurers, continued foreign direct investment, continued global economic growth to keep U.S. export revenue growing, and a moderation in oil prices, to get the U.S. economy on the trend-growth track again.
"This current economic slump is complex and will require all of the U.S.'s policy tools -- monetary, fiscal, regulatory, private investment -- to correct past economic mistakes," Affinito said. "And if the economy is growing by this time next year, trust me, we'll all be very happy with that."
