Tags: Rate | Cuts | and | Stimulus

Rate Cuts and Stimulus Won't Work

Friday, 01 Feb 2008 04:31 PM

Last week, I told investors who attended our investment seminars in California that neither the Federal Reserve nor the U.S. government would be able to prevent a continuation of the slowdown in the U.S. economy by lowering short-term interest rates or by providing a tax rebate to consumers.

Since then, the Fed has cut the target Fed funds rate by 125 basis points, to 3.0 percent, and the U.S. Senate has approved the House of Representatives' economic stimulus plan.

My analysis was (and continues to be) based on the following:

The overall employment situation in the U.S. is continuing to deteriorate

Aggregate consumer incomes are declining

The housing market remains in a slump

Total household net worth is falling as a result of declining stock prices and falling home values.

In addition, consumer debt as a percentage of after-tax consumer income is near an all-time high and consumers' confidence about future economic conditions is worsening.

In light of these factors, my models indicate that U.S. consumers will continue to rein in their spending during the months ahead and that corporate revenues will therefore decline.

debt owed by consumers currently represents approximately 24 percent of their after-tax income, and most consumers are now unable to tap into home-equity loans (due to the continuing declines in home values).

As a result, I expect most consumers to use the majority of any tax rebate that they receive from the government to pay off a portion of their debt rather than to spend on new purchases of goods and services.

In regards to the Fed's significant reductions in the target Fed Funds rate, I suggest you keep the following in mind: the Fed funds rate is the interest rate that commercial banks charge other banks to borrow funds on an overnight basis — not the rate of interest that banks charge on loans to consumers or businesses.

Hence, there's no reason to assume that debt-strapped consumers will suddenly decide to increase their bank borrowings to fund purchases of consumer goods and services.

And, with bank's continuing to tighten their lending standards, there's also no reason to assume that banks will make more loans to consumers or businesses at rates anywhere near the Fed funds rate.

However, there is one likely outcome of the Fed's recent rate cuts – more inflationary pressures.

The reason is this: When the Fed lowers its Fed funds rate, it negatively affects the exchange-value of the U.S. dollar. That's because foreign investors are less likely to invest in U.S. Treasury securities whose yields are closely tied to the Fed funds rate.

Meanwhile, persistent increases in the prices of raw materials suggest that corporate operating expenses could continue to rise. Hence, I expect corporate profits to decline considerably during the first two quarters of 2008.

As most of you know, stock prices generally follow the direction of corporate profits.

Although stocks, as measured by the S&P 500 Index, rallied sharply on the day of the Fed's Jan. 22 emergency 75 basis point rate cut, stocks have since traded in a narrow sideways pattern, over the past week.

Stocks did manage to rally again today. However, my technical models indicate that stocks in general have likely run into overhead price-resistance levels and that the major stock-market indices will pull back again tomorrow.

On a longer-term basis, my fundamental models indicate that stock prices will continue to trend lower during the weeks ahead.

Perhaps the most disturbing development during the past week was the big jump in new claims for unemployment benefits, which rose by 69,000 during the week ending Jan. 26 to the highest level since February 2004 (excluding the aftermath of Hurricane Katrina).

If tomorrow's non-farm payrolls report shows that overall job creation also continued to slow during January, and that the unemployment rate ticked higher again, I expect stock prices to drop sharply tomorrow and to fall back to their levels preceding the Jan. 22 emergency rate cut.

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DavidFrazier
Last week, I told investors who attended our investment seminars in California that neither the Federal Reserve nor the U.S. government would be able to prevent a continuation of the slowdown in the U.S. economy by lowering short-term interest rates or by providing a tax...
Rate,Cuts,and,Stimulus
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2008-31-01
 

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