Fed cuts smack savers
Fed cuts smack savers
Fed not doing savers any favors
Ben Bernanke made it pretty clear last week that the Fed intends to cut interest rates again. A poor employment report this Friday could prompt the Fed to cut rates immediately rather than waiting until the regularly scheduled March 18 meeting. I hope it doesn’t come to that, but an overtone of weakness to this week’s economic data could bring calls from Wall Street for the Fed to do something pronto. As we’ve seen, the Fed has been willing to cave to such pressure.
In addition to Friday’s employment report, tomorrow brings the ISM Services Index. That same index ignited the recession concerns a month ago when it plunged sharply, showing a contraction in the important services sector of the economy. A similarly poor reading this month would bring out the economic boo-birds calling for the monetary policy equivalent of a quarterback change … in other words, an immediate interest rate cut.
In my own humble opinion, that just seems to be bad policy. Fed interest rate moves act with a lag. Significant stimulus, in the form of repeated interest rate cuts already enacted, is in the pipeline and will bear fruit in the second half of 2008. Couple that with the forthcoming tax rebate checks, even if only a portion of that money gets spent, and you have what could amount to a rebound in growth from a very modest, and short-lived, downturn.
The Fed rate cuts have already done something that no foreclosure relief plan or consortium of lenders and government muckety-mucks has been able to do, reduce the financial sticker shock from resetting adjustable rate mortgages for many households. Look at two common ARM indexes, the one-year Treasury and the 6-month LIBOR, compared to last summer. The 1-year Treasury yield has fallen off a cliff, from 5 percent to 1.75 percent now. And the 6-month LIBOR, aided by the Fed’s Term Auction Facilities of the past few months, has fallen from 5.3 percent last summer to 2.86 percent now. This is substantial and translates into manageable payment increases for many borrowers, particularly prime borrowers more so than subprime borrowers, but even they’ve benefitted from the reduction in interest rates.
If you are a prime borrower facing a reset on the 5-year ARM taken in 2003 at 4.5 percent, the drop in interest rates engineered by the Fed means instead of your Treasury-indexed ARM jumping to 7.5 percent or more, as it would have had it reset last summer, your new rate is (tada!) 4.5 percent! Looks a whole lot like the old rate, doesn’t it?
Cutting interest rates further only subjects us to the clutches of the inflationary beast later. And we may already be gearing up for a battle on the inflationary front, unless the Fed happens to be correct and the much-prognosticated moderation in inflation pressures actually takes place.
Savers and fixed-income investors could throw up a justifiable objection to all this Fed action and inflation flirtation as they are effectively subsidizing their overly indebted neighbors whom the Fed is so geared toward giving an interest rate mulligan. After all, yields on cash investments have gone from yields well north of 5 percent to levels that now are below the rate of inflation, putting investors’ real yields in negative territory. With cumulative Fed rate cuts having virtually erased ARM reset rate increases for many homeowners, and the broader economic boost to become evident in the months to come, it’s time for the Fed to stop. Savers and fixed-income investors are paying too high a price through no fault of their own.