The Wall Street, investors, banks and several others are eagerly awaiting Federal Reserve Chairman Ben Bernanke's decision today. After the emergency rate cut of 75 basis points last week, there is skepticism among economists and experts about another rate-cut from the Federal Reserve Chairman. Many people believe that Bernanke would not "dare" to offend the market right now. The market is expecting another 50 basis points cut and there is a high possibility that it will get exactly that. This is especially true after the GDP numbers came out today. The GDP growth dropped down to an extremely measly 0.6% for the last quarter (October – December). This was much worse than anyone's expectations. Even the Street which is in a pessimistic mode and a bearish mood was expecting at least 1.2%. In the third quarter the GDP growth rate was 4.9% which is what it should be for a strong economy like ours. 0.6% GDP growth rate does spring up fears of recession and that would be playing strongly in Bernanke's mind. I think that Bernanke will reduce the Fed Discount Rate by 50 points as well.
Fed Funds Rate is the rate at which banks and financial institutions lend money to each other. This is the rate that was slashed by 75 basis points last week. This rate is now at 3.50% and with another 50 basis points cut today, it would drop to 3.00%.
Fed Discount Rate (or the Discount Window) is the rate at which Banks and Financial Institutions borrow money from the Federal Reserve Bank. This rate is currently at 4.00% and if cut by 50 points today, it will drop to 3.50%.
The only question I have is should Mr. Bernanke do what the market wants or should he do whatever is best for the US economy? How will these rate-cuts affect the future of US economy? These incessant rate-cuts are driving the US Dollar to new lows every-day. The current inflation rate is 2% to 3%. If the Feds cut their benchmark rate today then the federal funds rate adjusted for inflation would be close to 0 or even negative. This indicates a significant risk of inflation just a few months from now. Also, let's assume that the Feds do cut the rate by 50 points today and the market rallies on this news. But will the rally sustain? Does this rate-cut indicate an end to the market woes? I don't think so. The fear will prevail in the market even after this rate-cut and may be after a few dead-cat bounces, the key indices will go for a free-fall. Even if there is a "false rally" for the next couple days or more, any bad news on the financial front would be enough to drag down the indices lower. Right now the fear in the market is unprecedented. Even the good news is viewed negatively and the investors need only an excuse to shift to a bearish mood. The market will need time to regain its lost confidence. Also the US economy needs much more than just rate cuts. The stimulus package might not be enough to bolster the economy. I am really hoping (and praying) here that the feds and the government are doing whatever is best for the economy in general.
I know it's easier said than done. The current situation is so dicey that no one would want to be in Mr. Bernanke's shoes right now. Recession? Inflation? Well, how about Stagflation? There is a growing fear of Stagflation here and the rate cuts would only bring it closer to a reality. Stagflation is like a 'double whammy'. It's a period of both economic sluggishness as well as rising price pressures. Basically, stagflation = inflation + recession. In the near term, the US economy will most probably have a very bumpy and unpleasant ride and chances are that absolutely nothing can prevent it; not even the fact that it's an election year. Of course the US economy will survive this appalling period like it always has and in several months from now everything will be bright and sunny again.
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