The First Cut is the Deepest

Good day… And a Wonderful Wednesday to you! Well… As widely expected, the Federal Reserve cut the Fed funds and discount rates. What wasn’t expected, except from me, was exemplified in the question my colleague Ed Bonawitz asked me on Monday. “What do you think the size of the cut will be?” My answer: 50 Basis Points (BPS)! And that’s what the Fed did on Tuesday… 50 BPS!

Borrowing a line from the Cat Stevens song, made popular by Rod Stewart and then Cheryl Crow… The Fed decided to make the “first cut…the deepest” baby you know! Or maybe Big Ben is a fan of the Rocky and Bullwinkle show, and decided to imitate Bullwinkle… “Hey Rocky, watch me pull a rabbit out of my hat!”

Did they panic? I believe so… But then they could have opted for 50 BPS to be “one and done”. I did three interviews yesterday afternoon after the rate cut, as business writers wanted to know what I thought about the size of the cut. I told them that the Fed had hit the panic button. I would rather they kept their eye on the inflation ball than come to the aid of the markets. I also think the Fed cut 50 BPS thinking that they would detour around a recession.

It’s too late baby, now it’s too late… The wheels are already in motion for that major slowdown/recession, and there are a few things that really scare me about this rate cut. But first, I have to tell you that the currencies went hog wild after the news of the cut. The euro (EUR) jumped up one cent, the Canadian dollar (CAD) jumped over a cent to come within spittin’ distance of 99-cents! And the high yielders, now knowing that their positive interest rate differentials had opened up like the Red Sea, rallied like there was no tomorrow!

I received a couple emails yesterday from people telling me that I was wrong to say that the dollar would get taken to the woodshed once the Fed began the rate cut cycle, because in 2001 that didn’t happen. Ahhh grasshoppers… Let’s take a trip back to 2001. The only economy that had been worth investing in was the United States. The world was basically attempting to get out of their own respective recessions, and their rates were low. Does that sound anything like what’s going on now? No. We have strong global growth and higher interest rates than the U.S. around the world; and our current account deficit now accounts for over 6.5% of GDP. Back in 2001 it was around 4.5% of GDP.

OK… Now that I’ve gone through that… Let me tell you what scares me about the 50 BPS rate cut…

1. It doesn’t do anything to help the liquidity/credit crunch.
2. It allows inflation to take hold even more.
3. Stocks had better start kicking some tail to attract foreign investment, because our deposit rates aren’t going to!

The things I like about the rate cut? Well… As evidenced by the move yesterday, the currencies are stronger. Gold is higher… In fact it soared after the rate announcement! And maybe some of those people that have ARMs about ready to reset will get a better rate!

I had written that I thought the Fed would come back next month with another rate cut and then one in December to finish the year… The wording of the Fed statement has me reconsidering that thought… But then, as we go forward, if we begin to see data that indicates the economy is eroding further, the markets will second-guess the Fed, and the Fed will react.

PIMCO’s Bill Gross sees 3.75% as the destination for interest rates… So, he obviously is thinking along the same lines as yours truly.

What really ticks me off about the Fed cutting rates is all right there in black and white. The Fed stated that, “some inflation risks remain.” IF INFLATION RISKS REMAIN, WHY ARE THEY CUTTING RATES?

OK… We also saw PPI yesterday, which basically collapsed, falling 1.4% from last month, and down to 2.2% annualized from a previous reading of 4% annualized. So… If you want to believe this (which I don’t), you should know that PPI tends to lead CPI by 12 months.

The TIC’s data was pretty strange… The long-term purchases only amounted to $19 billion, but the overall net purchases, including T-Bills, and short-term instruments, were higher. When I put a pencil to this data, I found that the average month so far this year has totaled $75 billion per month – almost exactly what is needed on a monthly basis to finance the deficit.

So… Sliding by on the skin of its teeth… Boy that sure gives me a warm and fuzzy!

Today, we’ll see that stupid CPI report for August… The latest housing tarts data… If the lies continue about inflation, the dollar won’t get any backing.

And in what now seems to be my daily check on the price of oil… It reached a new record level over $82 yesterday after the Fed announcement. And that had a lot to do with the Canadian dollar/loonie pushing higher on the day.

The newest member to the roster of currencies we offer, the Brazilian real (BRL), soared to a six-week high after the Fed rate cut announcement… Brazilian rates are now more attractive than those in the United States.

I’m about all out of things to talk about today… I could get all lathered up over the news that retail sales in Switzerland posted a nice gain for the 14th consecutive month. This data gives the Swiss National Bank (SNB) the “I did good” ribbon, given their rate hike just last week. If it weren’t for that darned carry trade, Swiss francs (CHF) would be running with the euro… But even with the carry trade, the franc has posted some nice gains versus the dollar this year!

Or… I could get goose bumps over Japanese Department Sales, which rebounded in August… But I won’t, because this is a prime example of Japanese data… It lures you in, and gets you thinking that the Bank of Japan will raise interest rates, and then… WHACK! The next data series shows something completely opposite, and you’re left there with your Japanese pennant in your hand… Your foam #1 finger drooping… And a sour taste in your mouth! Or… Wait, I could be talking about my beloved Cardinals this year too! But… No, I’m sticking to my story on Japanese yen (JPY)!

Anyway… As the dust settles on the rate cut today, we’ll have all the usual suspects giving their opinion on how they see the whole shootin’ match. Of course I didn’t have time to digest the news, as I was called to do interviews with my opinion immediately after the rate cut announcement! But, I doubt I would have said anything different.

So… There you have it… The big question now is whether or not this was a “one and done” rate cut. We won’t know that for sure until we move along into October and see the color of the data here in the United States. I’m thinking that it will continue to disappoint, and that the fed comes back to the rate cut table. But then… I don’t have any information that you don’t… It’s just my opinion!

Currencies today: A$ .8520, kiwi .7320, C$ .9895, euro 1.3975, sterling 2.012, Swiss .8460, ISK 63.40, rand 7.1020, krone 5.58, SEK 6.6360, forint 180.90, zloty 2.7050, koruna 19.8450, yen 115.90, baht 31.90, sing 1.5070, HKD 7.7860, INR 40.2175, China 7.5130, pesos 11.00, dollar index 79.30, Silver $13.14, and Gold… $731.60

That’s it for today… Did you know that today is officially called “Talk Like a Pirate Day”? Arrrrg! Ann Hopkins decided that we all needed pirate names on the desk for today. Mine is Iron James Kidd… So get your parrots and peg legs out of the closet, and talk like a pirate today… Arrrrg! OK, enough silliness… Time to get to work! Now… Where is that eye patch? Have a Wonderful Wednesday!

Chuck Butler — September 19, 2007

The Daily Reckoning