Will the Fed rate cut make any significant difference?

I have seen reports suggesting that the cutting of the federal funds target rate by the Federal Reserve will not make a big difference, but such claims usually fail to note the overall context of the federal funds rate. Yes, it is true that consumers will not directly see much change in their lives as a result of changes in the federal funds target rate, but it is a key rate that affects the flow of money within the banking system and in business in general. An incremental change in the federal funds target rate does provide incremental help to the banking system and to business in general. The problem right now is that the banking system is under such stress that borrowing money from the Federal Reserve or even from other banks is not really the main worry. The big worries are figuring out how to restore sanity to bank balance sheets and to attract deposits to be used as capital for lending.

In truth, the federal funds market is really only intended to narrowly moderate a normal and healthy banking system. The problem is that the U.S. banking system is not what you would call normal and healthy. It is not a complete disaster either, but many banks are in serious need of recapitalization and attraction of new deposits as more important factors.

That said, banks can use all of the help they can get, and a significant reduction in overnight lending rates is certainly one piece of the puzzle.

I would also note that a wide range of lending rates are in fact driven by the federal funds rate, including the prime rate and the new commercial paper funding facility. Other rates are based on the federal funds target rate as well, but many of them have been overwhelmed by the credit risk spread that is added to the federal funds target rate that the Fed does not control.

Maybe that is the essence of the problem in general, there are two variables and the Fed only controls one of them.

In any case, it appears to me that the latest Fed rate cut will in fact make a significant difference and probably within the near future. That said, there are plenty of delayed effects that usually take weeks or even months before changes in the federal funds target rate filters throughout the banking and financial systems and business in general.

If you do not mind oversimplifying, we can say that businesses will see an upside within two months and consumers within four months.

-- Jack Krupansky