Saturday, September 22, 2007

The Fed will...

After the "surprise" Fed rate cut of 50 basis points on Tuesday, all bets are now off as to what the Fed will be doing with their target rate over the next six months. Since Fed officials have not yet talked publicly at length and in detail about their "thinking" on Tuesday, we simply do not know their intentions. And to be sure, it depends on how the economy and financial markets and credit play out over the coming weeks and months.

Although it is possible that Fed officials actually intended to surprise people, I strongly suspect they were simply influenced by the last minute conversations with business leaders that occurred in the final days leading up to the FOMC meeting. I even noted last week that these conversations could likely bias the decision. I strongly suspect that executives and bankers expressed a dramatic degree of alarm and concern that circumstances stood a very real prospect of deteriorating very rapidly in the coming weeks and months. Not so much that this was the central outlook, but that the uncertainty over the outlook was simply too great. In other words, business and banking leaders probably expressed concern that there were simply way too many question marks hanging over everybody's heads and that it is way too difficult to make confident decisions in such an environment. The decision to go with a half-point cut was probably derived from the same thinking: People were struggling under too heavy a burden and an aggressive move was the only way to quantitatively and qualitatively buoy sagging spirits. This is my suspicion, but I do strongly suspect that those final expressions of "sentiment" tipped the balance and in fact made the decision a slam dunk that was in fact unanimous.

I do believe that the Fed made the wrong decision on a technical basis, but "animal spirits" are always a key concern even if not expressed in the technical equations. So, in some sense I do support the Fed's actions, but I sure do hope that they reverse their move ASAP. As things stand now, the Fed has completely destroyed its inflation-fighting credibility. I do suspect that the Fed will seek to re-establish their credibility on that front next year, but it will be a tough row to hoe given that even when faced with a "mini" crisis, the Fed blinked.

-- Jack Krupansky

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