RealTime IT News

The Fed Again Takes Center Stage

A lot of market participants seem to be expecting something dramatic and different out of the Federal Reserve meeting today, but they're likely to be disappointed.

The Fed doesn't do the unexpected, at least not at FOMC meetings. Which means that what the Fed will likely do today is to cut rates by 25 basis points and issue a statement saying that the risk of weakness remains greater than the risk of inflation. Any variation on the theme will likely come out of that framework.

Some are saying that the Fed should leave rates unchanged and signal its confidence that the previous six rate cuts are beginning to work. That could spur business investment that has been delayed in anticipation of further rate cuts, but it could also make the Fed appear dangerously out of touch if the economy were to continue to weaken.

On the other extreme, some are calling for a 50 to 75 basis point cut, but that would only call attention to the fact that the previous rate cuts have done little to help. As we have pointed out in the past, the only other period that failed to respond to this level of rate-cutting was 1929-1930. Aggressive rate cutting after the Fed has already moved to a slower easing pace would send the message that things are worse than previously thought.

The most reasonable variation is that the Fed could include a statement that there are early signs of recovery. Not an unreasonable statement to make, and one that could cause the markets to rally. But again, the risk is that the Fed would appear out of touch if the economy continues to worsen, and that's about the worst thing that the Fed can do.

We'll know soon enough, at 2:15 p.m. this afternoon. But signs of weakness remain the predominant trend.

On the surface, yesterday's 0.3% rise in the index of leading indicators was encouraging. However, much of the increase was due to an increase in M2 money supply. As we mentioned recently, M2 is growing at double-digit rates, but M2 velocity - the rate at which that money is changing hands - is falling. Fed liquidity injections aren't much help if economic activity remains weak and demand for credit is declining.

And a week from tomorrow, second-quarter GDP will be revised downward, possibly into negative territory. With the domestic private sector - about 85% of the economy - contracting at a 0.2% rate in the second quarter, it's not unreasonable to say that the economy may already be in recession. The only thing holding up is government spending, and budget surpluses are disappearing rapidly.

Much has been made of how the economy and consumer spending are holding up, but the rapid descent from strong growth to anemic or no growth has been one of the steepest, if not the steepest, of the post-war economy, and aggressive Fed action has done little to help. It would be comforting to hear some serious discussion of these issues.