Fed to Cut Rates to 3% or Lower
The housing and
financial woes have now clearly spread to the overall
economy....
...And together with expensive energy are pushing the economy towards
recession.
Fed is behind the curve and has to act more aggressively to avert a
protracted slump...
...Action that is likely to be supported later on by the fiscal
authorities.....
Housing and
financial woes...
The housing downturn started in early 2006, but at first its effects were
contained as other sectors of the economy still thrived well. However, the
situation deteriorated in 2007 when it became clear that excesses had built up,
not only in the housing sector itself, but also in the mortgage sector
(especially sub-prime).
In mid-2007, the financial sector was hit hard by the subprime turmoil,
witnessed by a freezing of the money market. The situation escalated though and
a wholesale credit crisis was born. At the end of September, we lowered our
expectation for the Fed Fund target rate to 3.5%, at that time a rather bold
forecast. We speculated that the housing market woes combined with a tightening
in lending conditions would infect the real economy starting by the consumer and
manufacturing sectors.
An additional negative economic development, which we didn''t take into
account at the time of our rate forecast, was a further rise of crude from about
80 USD/barrel in H2 of September.
Tsunami lands in the real (eco) world
Since the turn of the year, a number of eco data finally showed that the
above-mentioned underlying factors have infected the real economy with recession
risks rising fast. The drop of the ISM to well below the 50 level is a bad omen,
but also leading indicators & the Chicago National Activity Indicator all
point to sharp increased risks of recession. The Payrolls report added to the
bleak picture by suggesting that the job generating machine had stopped,
especially if one takes into account that the reported job growth is
overstated.
We don''t go into all housing data, that were very weak, but the 6.1% Y/Y
decline in house prices (11.2% on a 3 month annualized basis or 6.6% decline
from the top) suggests an acceleration of the downtrend. Professor Shiller of
the S&P/Shiller house price index) reckons that house prices may fall up to
20/25% from the top. One shouldn''t underestimate the consequences on wealth and
consumer spending from such a dramatic fall, especially as it won''t be offset by
rising equities.