It is highly doubtful whether anything good can come from Bernanke acting like a clown at a children's party, jumping out of a wardrobe waving his surprise 75 basis point interest rate cut.
The initial reaction will almost certainly be shock "What??? They cut by how much??" However, after a few minutes of reflection, a second more dangerous thought takes hold. Perhaps, the US economy is diving into a deeper recession than originally thought. After all, why does the Fed feel the need to cut so aggressively? Shock will be quickly replaced by concern.
Looking beyond a 24 hour horizon, it is hard to see how this cut could help much. Adjusted for inflation, fed rates are now negative. US inflation is accelerating, and reducing rates can only weaken the dollar, which is not exactly a recipe from price stability
The Fed appears to be, for all practical purposes, unconcerned about inflation. This will ultimately begin to affect inflationary expectations. Over the longer term, the Fed could be reviving the reputation it had from the 1970s. When it come to inflation, the Fed is a weak and accommodating central bank.
Although the Fed's amateur dramatics will grab headlines, the US housing market is extremely unlikely to benefit much from this cut. According to bankrate.com, the 30 fixed rate jumbo mortgage interest rate is 6.5 percent, which is approximately the same level it was at in mid-2007. After record sub-prime losses, US banks have significantly tightened their lending criteria. The days of easy mortgage credit are gone and will not return any time soon.
Likewise, consumer credit is unlikely become cheaper either. This largely reflects a growing concern about the capacity of US consumers to repay their loans. Banks are anxious to reduce exposure, while Wall Street isn't in any shape to repackage this debt and lift it from bank balance sheets. Currently, credit card rates average between 10-14 percent. These are not the type of rates that would encourage a recession-avoiding spending spree.
This recession was booked and paid for three years ago. The US housing bubble created massive macroeconomic imbalances that could only be resolved by an economic slowdown. Rising inflation has eroded the incentive to save. Personal household balance sheets are overloaded with debt. The current account deficit is unsustainable. Lending standards have been too lax, and pushed the financial sector to the brink of crisis. Another round of easy fed money does nothing to solve these problems.
It would have been better if the clown had remained in the wardrobe.