Wednesday’s Wash

The Federal Reserve elected to cut the Federal Funds rate 25bps from 4.50% to 4.25%. 

Changes in the statement include a much clearer acknowledgement of economic weakness:  Last month – “…the pace of economic expansion will likely slow in the near term.”  This month the Fed highlighted the deteriorating conditions beyond the financial markets, “Incoming information suggests that economic growth is slowing, reflecting intensification of the housing correction and some softening in business and consumer spending.” 

The Fed maintains concern of upward risks to inflation.  “Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation.”

Last month the committee judged the “the upside risks to inflation roughly balance the downside risks to growth.”  This month the Fed has clearly revised their view on economic pressures.  “Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation.”

The Fed is ready and willing to take further action with a clear easing bias in place. “The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.”

In the votes last month there was dissension among the ranks; Thomas Hoenig voted against the 25bp cut, he preferred no change in the FF rate in October.  This time around there is still dissension; Eric Rosengren preferred a 50bps cut. 

Bottom Line: The Fed is not done yet; a clear easing bias in place, the Fed expresses genuine concern of further fallout in the real economy (beyond the wounds in the financial system).  These are uncertain times and neither a quick recovery from housing nor a banking system self-help solution has come to fruition.  The Fed will continue to monitor the slowdown and will cut rates further to maintain economic growth.   

Thursday’s Trivia

The WSJ and Bloomberg have a few more detail about the subprime bailout this morning, some of which raise more questions than answers. From Bloomberg:

 

• Eligibility limited to those who are behind on payments.
• Eligibility limited to those who are at least 97% LTV.
• Eligibility limited to those who have FICO scores under 640.
• Only loans originated between Jan 2005 and July 2007 will be eligible.

 

The idea here is that only those who cannot refinance or easily sell their homes need help. Also, by being so specific, the administration hopes to keep the program small while helping those that need it most. From the WSJ:

 

• The plan includes an agreement between originators of the loan and the investors that own the mortgage debt.
• The agreement sets terms for freezing mortgages and is nonbinding.
• Treasury claims it already has support of major investors.

 

In conversations with customers today, the biggest concern is that they might be forced into accepting a deal against their will. Many will be relieved to hear that the deal is only binding if they agree to it, but it’s hard to conceive how this can be achieved. There are many investors on the hook for each pool, after all. But the target group is so narrow that it may not be as hard as all that to pull off the plan. Most deals allow for 5-10% loan modifications anyway, at the discretion of the servicer. That may be enough to cover this small group.

 

The top story in this morning’s China Daily, meanwhile, is likely to prove a much bigger deal to US markets and the US economy. The central bank, concerned that inflation is getting out of hand, has announced that it will shift to a “tight” monetary policy next year. That means more aggressive rate hikes and very likely a faster appreciation of RMB vs the dollar.