Vital Market Signs at Selected Prior FOMC Meetings

December 16, 2008

  EUR/$ $/JPY 10Y, % DJIA Oil, $
06/30/04 1.2173 109.44 4.63 10396 37.95
06/30/05 1.2090 110.89 3.96 10370 57.00
06/29/06 1.2527 116.07 5.20 11077 73.41
06/28/07 1.3452 123.17 5.10 13456 69.82
08/07/07 1.3749 118.55 4.73 13510 72.27
09/18/07 1.3888 115.75 4.51 13475 81.42
10/31/07 1.4458 115.28 4.42 13873 93.59
12/11/07 1.4682 111.49 4.11 13645 89.78
01/30/08 1.4792 107.31 3.70 12454 91.70
03/18/08 1.5786 98.73 3.41 12257 107.53
04/30/08 1.5562 104.58 3.83 12953 111.54
06/25/08 1.5568 108.37 4.18 11837 133.62
08/05/08 1.5445 108.42 3.97 11484 119.82
09/16/08 1.4144 105.16 3.36 10936 91.18
10/08/08 1.3625 99.87 3.50 9447 87.02
10/29/08 1.2933 97.15 3.81 9145 67.38
12/16/08 1.3763 89.84 2.50 8668 45.89

 

The Fed is perceived to have cut rates aggressively, yet there have been four scheduled FOMC meetings since the global financial market began when policy was left unchanged, those being in August 2007, June 2008, August 2008, and September 2008. The Federal funds rate was sliced from 5.25% to 1.0% in increments of 50 basis points on September 18, 2007, 25 bps on October 31, 2007, 25 bps on December 11, 2007, 75 bps on January 22nd of this year, 50 bps on January 30th, 75 bps on March 18th, 25 bps on April 30th, 50 bps on October 8th, and 50 bps on October 29th.

In the seven weeks since the last rate cut, ten-year Treasury yields have fallen 131 basis points. Oil prices have sunk 31.9%. The DJIA is 5.2% lower than then, and the dollar has depreciated 7.5% against the yen, 6.0% versus the euro, and 2.6% on a trade-weighted basis. Having already cut rates by a full percentage point between mid-September and mid-December of last year, the Fed administered a further 200 basis points of easing compressed into two months by mid-March 2008. The subsequent nine months is sufficient time for that heavy dose of stimulus to have reaped discernible results. Instead, economic activity declined at an accelerating pace in 4Q08, and the risk of deflation is mounting. It is quite plausible that U.S. real GDP will cumulatively decline by 2% in this and next quarter alone, which would represent two-thirds of the entire peak to trough drops in the two previously most severe postwar recessions. Housing starts slumped 47% in the year to November, including 18.9% in November alone. U.S. consumer prices fell 8% saar in the four months to November, and the 4.5 percentage point drop in on-year consumer price inflation from 5.6% in July to 1.1% in November was the sharpest four-month reduction since a decline from 6.9% in November 1951 to 1.9% in March 1952. Producer prices posted consecutive monthly decreases of 2.8% in October and 2.2% in November.

The lessons to be gleaned from these facts are that monetary policy has not been a very effective safeguard against severe recession, deflation is a more pressing risk now than imagined a few months ago, and now is not the time to get timid simply because officials are running out of room to cut nominal interest rates. I believe the FOMC will announce a bigger reduction than 50 basis points.

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