The Fed surprised all of us by cutting Fed fund rate by 1/2 percent today. Although economic and political pressure was strong enough to warrant a cut, no one preducted a big 1/2 percent cut. The stock market rallied, having the Dow gain its biggest one day gain in 5 years by more than 300 points. However, we have to remember why the Fed cut rate. They cut the rate because they are trying to prevent the big "R"!!!
The Fed, citing the growing risk to continued economic growth, cut the benchmark fed funds rate by half a percent Tuesday, a bigger cut than many economists had forecast. It was the biggest cut since a half-point cut in November 2002, and the first rate cut of any kind since June 2003.
While most economists still don't believe the nation will fall into a recession, there is general agreement that the economy now faces a greater risk than there was only a month or two ago.
But many economists also say that the Fed can do little at this point to address many of the factors threatening continued economic growth. Some economists even argue that rate cuts could make matters worse.
The mortgage market would seem to be where the Fed could have the most effect. Most directly, a rate cut will reduce the rates for adjustable rate mortgages, one type of loan that has caused the problems for lenders and subprime borrowers, those with less-than-perfect credit.
An estimated 2 million homeowners face sharply higher mortgage payments when their current loans reset over the next year. So a Fed rate cut could possibly stave off a wave of foreclosures.
That's key since more foreclosures could have the potential to hurt consumer spending as a whole, said David Wyss, chief economist for Standard & Poor's.
About 1 or 2 percent of the population is going to be seriously affected by these resets. That's not trivial. One thing a Fed rate cut will do is reduce that reset shock fairly quickly.
But even a series of rate cuts won't solve the problem for those who have been paying low teaser rates on their mortgages with the expectations that they would be able to refinance before rates reset. The fact that investors no longer are willing to buy securities backed by such non-traditional mortgages could make it impossible for hundreds of thousands of those homeowners to refinance.
A rate cut even down to zero percent doesn't make those attractive investments. The Fed is in the situation where they should not be thinking about saving housing. They should be thinking about isolating the problem strictly to the housing sector.
The mortgage problems have clearly led to a broader credit crunch in financial markets, which has already put a crimp on the financing of some proposed mergers.
While rate cuts may help get those markets functioning more fluidly once again, there is debate among economists about how great a risk the credit crunch poses to the overall economy. I am not convinced that a rate cut would boost the economy and create jobs. Outside New York, there shouldn't be much impact.
I don't think the Feds signaled that there will be more cuts; I don't think they know what they'll do at the next meeting, as a mater of fact, I believe the Fed did its best to signal that future cuts are not certain.
But there will be economists out there predicting this is the first of a series of cuts, if people believe that, it gives them reasons to have doubts about the economy and a reason to wait to make investment decisions. If you're trying to pick up a house at a bargain, will you do it now or wait six months? You'll wait six months.
Another risk to the economy would be a drop in foreign investment here, according to some economists. And a Fed rate cut might cause more problems than it fixes because lower rates would make some U.S. investments, such as government-issued Treasurys, less attractive to foreigners.
Last year we had $1 trillion come in net foreign investment, most of it into the bond market, and most into private bonds, not Treasurys. If that money stops coming in, that's going to be a big increase in borrowing costs.
A sharp drop in foreign investment would also feed into the slide in the value of the dollar. While that would make U.S. exports more competitive, it also would likely raise the price of imported goods and hurt the spending power of U.S. consumers, who have come to count on low-price imports for everything from food to clothes to cars.
The Fed also has little ability to affect another risk to the economy: high oil prices. Crude oil prices hit $82 a barrel for the first time in Sept, and hit record-high closes both Monday and Tuesday.
While the economy has kept growing with oil in the $60s and $70s, economists say rising prices are a bigger risk now given how vulnerable the economy is. High oil and gas prices would be just one more thing for an already nervous consumer to worry about. I think if this lasts for two to three months, it's going to be a problem. If this was happening when the economy was going great guns, I wouldn't be as concerned. But more than just the costs, this can affect consumer psychology. If it shows up at the pump, then we've got some problems.
So what do we do? First sell the stocks you have already profited in. Which should'nt be too hard, after the big increase today. Take some of that cash and put it in CDs. There are now CDs that yields more than 5%, if you shop around. Assuming you invest $100k, in one year, you are getting $5,000 risk free.
If you still want to make money in stocks, try the recession proof stocks. Such as food, consumer staples. Also buying index funds woud help reducing the risk of that one company going bust, but gaining from a whole sector's overall strength. If you believe oil prices will continue to go higher and stay at this level, buy oil ETF. I recommend DIG. It is an ultra oil ETF.
