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This week, I had the pleasure of taking my oldest daughter to her kindergarten orientation. It was the coolest thing to see Maya looking all around at the art classroom, the cafeteria, and the model rocket and jungle displays on the walls.
I can’t wait to hear about all the new things she’s going to learn. But I also know that inevitably, she’s going to make mistakes along the way. The important thing is to make sure she learns from them and tries not to make the same ones twice.
Unfortunately …
This lesson doesn’t seem to have sunken in at the Federal Reserve.
Prior to this week, the Fed had slashed short-term rates by 300 basis points. The response from the housing market — what the Fed was ostensibly targeting — was essentially nil. Prices continued to fall, with the declines gathering steam every month. New home sales slumped to the lowest level since 1991. Mortgage credit continued to tighten up.
In other words, the Fed’s cuts were NOT working. At the same time, those cuts were pushing real interest rates deeper into negative territory. They were also driving U.S. yields even farther below yields offered in other countries. They forced the U.S. dollar down dramatically and caused virtually every commodity price under the sun to soar.
The lesson of the markets was loud and clear: Enough! Stop cutting rates! Start focusing on what really matters: The ongoing deterioration in the U.S. dollar … the destruction you’re meting out on U.S. savers … and the loss of your inflation-fighting credibility.
But at 2:15 PM Wednesday, policymakers announced they were lowering the Federal funds rate again.
While leaving the door open to a rate-cutting pause, and ratcheting up their anti-inflation language ever so slightly, they didn’t come out with guns blazing.
They didn’t put currency and commodity traders on notice that they are ready to drop the interest rate hammer.
And they didn’t announce to the world that they are ready to get AHEAD of inflation and end this negative real interest rate nonsense once and for all.
In other words, they showed that they haven’t learned much from the past nine months of credit market schooling.
Why Isn’t the Message Sinking In?
Frankly, I just don’t get it. I can’t understand why they cut rates again, and why they won’t do something to demonstrate they understand the failure of their chosen course of action. And rest assured, it’s not just me that’s confounded by the Fed’s insistence on making the same mistake over and over again.
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| Legendary investor Bill Gross has been critical of the Fed’s aggressive interest rate cuts. |
Get a load of what bond king Bill Gross had to say about the wisdom of more interest rate cuts in his latest monthly commentary at the Pimco web site:
“Lower Fed Funds? They would, in PIMCO’s opinion, likely do more damage than good from this point forward. Foreign and domestic investors are being fleeced with negative real interest rates, and the weak dollar, stratospheric commodity prices and steadily rising import inflation are the result.”
Or how about this zinger from Andrew Lapthorne, an analyst with Société Générale in London, on the effect the Fed’s easy money policies are having on the commodity markets:
“As central banks pump in liquidity to help bail out the financials, the result so far seems to be ever higher commodity prices.”
And who could forget the April 15 column in the Wall Street Journal from Martin Feldstein, Chairman of the Council of Economic Advisers under former president Ronald Reagan? Entitled “Enough with the Interest Rate Cuts,” it said:
“It’s time for the Federal Reserve to stop reducing the federal funds rate, because the likely benefit is small compared to the potential damage.
“Lower interest rates induce investors to add commodities to their portfolios. When rates are low, portfolio investors will bid up the prices of oil and other commodities to levels at which the expected future returns are in line with the lower rates.
“An interest rate-induced rise in the price of oil also contributes indirectly to higher prices of food grains. It does so by making it profitable for farmers to devote more farm land to growing corn for ethanol. The resulting reduction in acreage devoted to producing food crops causes the supply of those commodities to decline and their prices to rise.”
This week the Fed chose to drive rates even FURTHER into negative territory — to -2% if you use a 2% federal funds rate and March’s 4% Consumer Price Index inflation reading.
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I want you to take a close look at my chart to see just how unusual this is. Real rates haven’t been this deep into negative territory going all the way back to 1980.
And it’s not like it’s just a one-month phenomenon. Rates have been in negative territory for a significant period of time since the dot-com bust. As my chart shows, we haven’t seen rates consistently negative like this since the bad old days of the late 1970s — you know, when inflation was through the roof, commodity prices were surging, growth was anemic, and so on.
Is it any wonder then that we’re seeing a lesser version of that awful stagflationary period now?
Yet the Fed still … STILL … refuses to demonstrate that it has learned anything from history.
What’s worse …
The Fed’s stubborn rate cuts are actually HURTING the very same people that Washington says they are trying to HELP!
Something else that I find ironic, in a painful and unfortunate way, is this: The Fed is supposedly running this extremely easy monetary policy to help the housing and mortgage markets.
But you know what 30-year fixed mortgage rates have done since the Fed started cutting last summer? You know what the whopping 325 basis points in federal funds rate cuts have meant to borrowers looking for long-term, stable mortgage financing? Practically zip! Thirty-year loans go for around 6% today, versus 6.4% last August before the first rate cut.
And that Mortgage Bankers Association index of home purchase loan applications? The one I just mentioned had fallen more than 6%? Well, it dropped another 4.8% in the most recent week. At 340.1, it’s now the lowest going all the way back to February 2003.
The cuts aren’t stopping house prices from falling, either. S&P/Case-Shiller figures for February show prices down a hefty 12.7% year-over-year in the 20 top metropolitan areas. Those are the steepest declines ever recorded!
In other words, we’re paying a lot more to gas up our cars, feed our families, travel abroad, and so on — partially as a result of the Fed’s easy money policy.
I sure hope the Fed gets with the program. I hope it stops cutting interest rates, and in fact, starts looking to normalize them. The Fed took baby steps in that direction this week — let’s hope it goes even further down that road.
Meanwhile, I hope it focuses its efforts on other, better ways to target aid at borrowers struggling to stay afloat — ways that don’t decimate savers and drive the dollar into the dumps. And I hope it happens soon.
Heck, my five-and-a-half year old can learn from her mistakes. What about you, Mr. Bernanke?
Until next time,
Mike
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