Fed Cuts Interest Rates to 0.25% and Formally Enters QE

The Federal Reserve cut interest rates by 75bp to a range of 0 to 0.25 percent, the lowest level that this generation has ever seen.

In our FOMC preview, we talked about how the Fed may consider adopting a BoJ style rate cut that takes interest rates somewhere between 0.25 and 0 percent. Although that was exactly what we saw today, we expected it to happen in March and not December. The Fed has taken another page out of the Bank of Japan’s book and will continue to follow in the footsteps of the Japanese central bank as they formally adopt Quantitative Easing even though they refuse to use those words explicitly.

It is no surprise to see the US dollar selling off aggressively as it is now the lowest yielding G10 currency. This was the right move for a central bank that wants to be proactive and no longer just reactive. There is no point for the Federal Reserve to play games anymore by denying what is already being priced into the markets. Cutting interest rates to 0.25 percent was inevitable and they rather deliver this stimulus now than later. Fed funds were trading as low as 0.15 percent going into the FOMC meeting. The Federal Reserve expects to keep interest rates at “exceptionally low levels for some time,” and to employ all available tools going forward including the purchase of long term Treasuries. In other words, the Federal Reserve is telling us that they are formally moving to Plan B, which is Quantitative Easing.

There is no question now that the Federal Reserve is the most aggressive central bank. Since 2007, they have cut interest rates by 500bp and since the beginning of year, they have cut by 325bp. With the economic outlook weakening and the financial markets remaining quite restrained, the Fed wanted to over rather than under deliver. This morning’s consumer price numbers also raises the risk of deflation, which may have pushed the Federal Reserve to make the larger move. The Fed did not indicate in the FOMC statement whether zero interest rates are still on the table, but an interest rate of 0.25 percent is just as bad.

The US dollar has embarked on a new downtrend and today’s interest rate decision only cements that. We expect more dollar weakness in the first half of 2009. There is a reasonable chance that USD/JPY could fall to 85 and the EUR/USD could break 1.43. And of course, I still love the AUD/USD trade.

Comparing the FOMC Statements:

FOMC Statement December 16, 2008

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

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FOMC Statement October 29, 2008

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.

The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.

Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, and San Francisco.

8 Comments

  1. Hi Kathy,

    How do you see Cable playing out in 2009?

    The BoE will probably go down to 0.25%?

    Many are calling c.$1.30 and the odd few Parity.

    Thank you

    SIMON

    Reply
  2. Hi Kathy,

    I came across your blog via CurrenyThoughts.com, Larry has link to your other web page.

    I have focused on UK Small Caps. but that has become a dead trade. With the UK in a dire financial state I began looking at hedging my capital in a few currency plays.

    I must admit I prefer Small Caps. but needs must.

    Will there come a point in 2009 when all the Central Banks are done cutting and stability will return to the Forex market?

    I am expecting the BoE and ECB to go down to ZIRP like the FED.

    If China has a hard landing and we get Japanised with an L shaped Global economy which currency would be king? Would it not be the mighty Dollar? Remember the European banks are the most leveraged in the World, have huge exposure to Eastern Europe, the riots have started already (Greece). Plus the Eurozone has high unemployment and a sclerotic economy. Is that not worse than the USA?

    Many are betting it will be Gold but if we go L shaped and have a good bout of deflation I don’t understand why Gold would do well.

    It is a very confusing time.

    The only trends I see are ZIRP, deflation and the L.

    Strangely I still believe in the Dollar…

    Reply
  3. Simon

    By the second half of 2009, all central banks will be done cutting interest rates. At that time, I expect us to enter into a range trading phase probably similar to 2006. The US will probably face a U shaped recovery with the bottom of the U lasting for some time.

    Gold is the ultimately form of safety especially with US rates at 0.25 percent.

    Hope that helps.

    Kathy

    Reply
  4. Kathy,

    You wrote “This morning’s consumer price numbers also raises the risk of deflation”. When you expect the current treasury bubble will burst, then investors liquidate their treasury assets and the deflation will turn to hyperinflation?

    Reply
  5. Kathy,
    Your blog is the most useful on the web for currency xchange play.

    Do you not think at all that ECB would bring down their Interest Rates? If and when that happens, USD should retain strength.

    Or is whatever is happening now the beginning of a long ‘quantitative easing’ phase as you have mentioned that involves no rate change from other major central banks leading to a perennially weak USD?

    Also deflation should bring down Gold too. Further there is no coupling of Gold to USD (not to DJI as well) in a direct way per se. What do you think?

    Thanks,
    Kalahasti

    Reply

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