March 19, 2001

The Fed: Caught Between the Proverbial Rock and a Hard Place

Both camps are right: the economy is "badly in need of a major jolt" and "an aggressive Fed move would encourage investors to take on more risk than they otherwise would (and) re-inflate the equity bubble." That's why the Fed has to tread carefully in cutting interest rates.

And it's not like interest rate cuts are a cure-all. The Fed has already cut rates by a full percentage point this year. The economy won't feel the effects of those cuts for another few months. But the effects of those rate cuts were felt on Wall Street instantly.

Both cuts in January resulted in a short-lived boost and clearly didn't stop stock prices from plunging. In fact, the January 31st rate cut is similar to what may happen tomorrow. The Street was hoping and praying for a three-quarter point cut but ended up with only a half-point cut. As a result, stocks plunged -- anyone who owned stocks in February can attest to that. Wall Street is fickle. Even a three-quarter percent cut tomorrow won't be enough to satisfy the Street. The Fed will have to cut rates by a full percentage point for stocks to rebound. And that won't happen.

The Fed also has to worry about the signal that they're sending to consumers if they cut rates more than the expected 50 basis points. Sure it will be cheaper to borrow, but consumers generally don't rush to make large purchases when the Fed confirms that the economy is in a recession. Consumer confidence, the key to turning this economy around, is a shattered myth already -- a significant Fed rate cut will make consumers even more nervous.

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