Fed feeds a frenzy
Maybe three-quarters of a point was enough after all.
Stocks took a nose dive yesterday, then powered their way to strong triple-digit gains, even after the United States Federal Reserve delivered a little less than the expected.
Markets on both sides of the border gyrated immediately after the announcement. Patricia Croft, chief economist at Phillips, Hager & North, said traders were initially disappointed the Fed failed to implement a deeper cut of 1 or 1.25 percentage points.
"It seems incredible, doesn’t it, that we are even mentioning disappointment and a 75 basis point cut in the same sentence?"
The disenchantment, however, was short-lived. Toronto’s S&P/TSX composite index closed up 184.55 points to 13,136.7. The Dow Jones industrial average surged 420.41 points to 12,392.66.
"I think the statement from the Fed makes it very clear the door has been left wide open for further rate cuts," Croft said.
The Federal Open Market Committee voted to lower the federal funds rate, which is the interest that banks charge each other for short-term loans, by three-quarters of a percentage point (75 basis points) to 2.25 per cent. Policy makers also lowered the discount rate, or the rate the Fed charges for loans to financial institutions, by 75 basis points to 2.5 per cent.
"Growth in consumer spending has slowed and labour markets have softened," the Fed said. "Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters."
The Fed also warned that "uncertainty about the inflation outlook has increased."
The central bank may have held back on a full-point cut to keep some of the powder dry, Croft said. The bank still has a way to go before the federal funds rate sinks to 1 per cent, a level not seen since 2004.
Nonetheless, some observers are openly questioning how much lower rates can go before cuts prove ineffective. "People are painting a lot of parallels with Japan, where interest rates went to zero, and the economy basically stayed in a period of essentially no growth for 15 years," Croft said.
"Are we at that point right now? Not quite. But the problem that the Fed has is they are cutting the overnight price of money but banks are still reluctant to lend."
The Bank of Japan re-adopted its 1999 policy of zero per cent interest rates between March 2001 and July 2006, after a lengthy recession.
In December 1999, Princeton University academic Ben Bernanke penned an essay questioning whether Japanese monetary policy was a "case of self-induced paralysis." The man who is now Fed chair attributed much of Japan’s dilemma to "poor monetary policy-making," including the failure to tighten policy between 1987 and 1989, despite creeping inflationary pressures.
"To this outsider, at least, Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced," wrote Bernanke. "Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work."
Fast forward to the current U.S. economic crisis. When asked what’s left in the Fed’s current bag of tricks, Croft said: "They’ve dusted off some tools that they haven’t used since the `30s. So, is there much more they can do? Not really."
TD Bank Financial Group has revised its U.S. economic forecast. Rather than a recovery starting in the second half of this year, the bank now expects growth to be flat through the first quarter of 2009.
That weakness is likely to spill across our border.
"I think our run of being largely impervious to the U.S same day payday loans. weakness is over," said chief economist Don Drummond.
"We are in better shape domestically, but we’re a trading country, and our exports are getting hammered."
TD is now expecting the Bank of Canada to cut interest rates by a half-percentage point at each of the central bank’s next three meetings, starting April 22.
- With files from the Star’s wire services
Star readers’ thoughts on U.S. woes
Will deepening U.S. economic woes spill over into Canada? Join the discussion at thestar.com/speakout
I am worried about the current U.S. economic woes spilling over into Canada. Because of the decrease in value of the American dollar the U.S. is becoming an attractive place to manufacture goods. This will leave Canada as a less attractive place to purchase goods for our neighbouring country and other countries around the world. This should be a big concern for Canada and especially industries such as the automotive sector. Canada needs to continue to transform into a knowledge-based economy to avoid an economic downfall.
Trevor Hall, Toronto
We should be worried about a global economic crisis rather than just the U.S. Most of the Western world is in debt and living an unsustainable quality of life. We’ve become totally dependent on economic growth as if it’s infinitely sustainable. We need to plan for a future without growth instead of continuing our addiction. If we couldn’t have sustainable budgets when the baby boomers were growing up, when the young outnumbered the old, how on earth do we expect to cope now? This goes as much for corporations as it does for our unions. Pensions are after all dependent on continuous growth (population and economic).
Yamin Bismilla, Brampton
Naturally the economic woes do spill over into Canada since the U.S. is our biggest trade partner. However, our financial institutions are much sounder since they are far less likely to irresponsibly give out loans and mortgages to people who can’t afford them. We also need to realize recessions and market downturns are great times for shrewd investors to get bargains. It’s not all bad.
Erin Martijn, Kitchener
Our governments in Canada need to get their heads out of the sand and start making changes before this economic disaster hits here. One major adjustment is the level of public sector wages, benefits and pensions which will take this country down and render us totally uncompetitive during the recovery process in the next few years. Our economy cannot afford such extravagance once the price of commodities (oil, gold, etc.) nosedive in the near future.
Doug Hayes, Lions Head, Ont.
When inflation begins to rise, as evidenced by prices of gold, oil and food at checkout lines, it is always important to increase the interest rate for borrowing. When the average debt in the U.S. and Canada is at an all-time high, I would think the U.S. Federal Reserve would make it harder to borrow money. When the price of flour, milk and eggs are up by more than 24 per cent in Silicon Valley, isn’t that a clue to bring the interest rate higher rather than decrease it? Almost two years ago the Federal Reserve policymakers raised a key interest rate to the highest level since 2001 and signalled that they may lift it further to combat rising inflation. I would think today’s policymakers would do the same thing.
Vince Dumond, Toronto