Why, why now, and what next? The answer to the first question as to why the Federal Reserve surprised everyone in the markets with another 50 basis-point rate cut between meetings is: Wayne Angell.
Angell, the chief economist at Bear, Stearns & Co, officially went off Fed Watch Tuesday, abandoning the idea of an inter-meeting rate cut following a report showing the first increase in industrial production in six months.
Recall that Angell, a former Fed governor, with the help of CNBC, had whipped the markets into a frenzy in late February, handicapping the odds of an inter-meeting cut as high as 90 percent.
Alas, the half-life of a Fed governor is short. If Fed Chairman Alan Greenspan wanted to disabuse the market of the notion that there is a Fraternity of Formers (Fed governors, that is), what better way than to pull the trigger just when Angell changed his call? Of course, Greenspan is also looking at his legacy.
It must stick in his craw to be reminded of his assurances to other Fed policy-makers in late 1990 that the US economy was not in recession -- several months after one had already begun.
If you're the Fed chairman and are convinced that inflation is well contained and the economy is growing well below a trend you can only fathom, why not execute a bold and daring move?
Safe at Any Speed
"He's making the world safe for 3 percent inflation," says Henry Willmore, senior US economist at Barclays Capital Group, in response to the fourth rate cut in as many months.
The consumer price index excluding food and energy rose an annualized 3.2 percent in the first quarter, the fastest pace since 1995. A quick glance at the Treasury yield curve before and after the intrest rate cut exposes yet another possible reason for the action on Wednesday
Until Wednesday, the federal funds rate stood out like a sore thumb at 5 percent, with yields on bills and notes out to five years well below it.
After the rate cut, the 4.5 percent funds rate is no longer a wart on the curve. Bill rates are still lower, which is their normal habitat, while the spread between fed funds and the two-year note is the narrowest since last August. At 4.22 percent, the two-year is well above the lows of close to 4 percent last week -- when the funds rate was 50 basis points higher.
Why now? The Fed refrained from cutting interest rates two weeks ago after the Labor Department reported the biggest decline in March payrolls in over nine years. Policy-makers remained steadfast in their optimism for a second-half recovery, even as last week's reports -- a five-year high in initial jobless claims, a decline in March retail sales and another dip in consumer confidence in April -- created a troublesome picture.
That's understandable because the Fed can't be viewed as responding to individual economic indicators, given the historical revisionism imposed on them.
Instead, the Fed chose a day to cut rates when the May fed funds futures contract had expunged any trace of an expected ease at the May 15 meeting.
It picked a day that is the exact midpoint between the March 20 and May 15 meetings. It did it on a day when the economic news was upbeat.
And it did it when stocks were rallying.
Earlier Wednesday, the Commerce Department reported a stunning US$6.3 billion narrowing in the trade deficit in February, which will lift first-quarter real GDP growth by as much as 1 percentage point. For some economists, that meant the difference between a negative and positive sign in front of their GDP forecasts.
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