FOMC OCT 2007 Dilemma: Rate Cut Versus Dollar Crisis

We do not have the final numbers in for today, but as of yesterday the 30-day FED FUND FUTURES contract wasn’t deciding IF the FOMC would cut rates.  It showed a 100% chance of a 25 basis-point rate cut for FED FUNDS from 4.75% to 4.50%.  But it showed a 14% chance that we’d see a 50 basis-point on FED FUNDS down to 4.25%.  We’ll know later tonight the probability of this today but it looks like that is now a 16% chance during trading hours.

But as our rates fall we run the risk of creating a further slide in the US greenback into a near crisis level.  That may be extreme wording, but it isn’t extreme from where we were.  Late today, the Euro cost $1.4362 per Euro and the US Dollar gets weaker more days than it doesn’t.  In January this was briefly under $1.30 and two years ago we were under $1.20.

The US Dollar and the Canadian Dollar now appear to be inverted with $1 US equaling C$0.9622.  $1 US now equals 114.29 Japanese Yen, although that reading hasn’t gone to hell in a hand basket like the US Dollar versus Canadian Dollars or Euros.  When it comes to many in the U.s. demanding that China decouple its strict peg to the U.S. Dollar, all that can be said is "be careful what you wish for, you might get it."

The U.S. consumer is stretched and it sure seems like the expected holiday sales may not come as well as even the revised retail associations are predicting.  real estate is still in the tube and we haven’t even reached the new mortgage rolls and resets coming in Jan-Feb 2008.  Inflation is dependent upon your review of whether or not we live in a nominal CPI world that includes food, energy, medicine, and insurance, or if we live in a core-CPI world that doesn’t include those prices.

The meeting decision will appropriately come on October 31, and the decision will hide behind a ghost mask until 2:15 PM EST on Halloween.  Hopefully November 1 being the Day of the Dead will only apply to Mexico’s celebration honoring dead family and friends.

It is the belief from 24/7 Wall St. that we have two more rate cuts coming with the potential for three more cuts, but it is our belief that the cuts from here on out will be in 25 basis-point increments barring anything much more drastic than we’ve already seen. 

The brokerage firm earnings were not all good and we won’t see the real effects from the 50 basis point cut already seen for another quarter.  Property prices have to still come down, and some more housing and car repos still have to get worked out.  Using the home as a piggy bank has ended and mortgage qualifications have tightened severely.

But there is some more that has to work itself out.  We have yet to see any real bank or lending institution failures outside of these leveraged mortgage brokers that were mere one hit wonders.  More pain is coming, but the FOMC has to take charge and do measured cuts from here to a true equilibrium rather than a big overshoot too fast.  Otherwise we’ll all be looking at our savings in U.S. Pesos.

Jon C. Ogg
October 26, 2007