By Jason Simpkins
Associate Editor
Until recently, Chairman Ben S. Bernanke was charged with the unenviable job of balancing the need to sustain economic growth in the face of mounting inflationary pressures.
But the developments of this past weekend have drastically altered the economic landscape and recent activity will certainly guide the Federal Open Market Committee’s discussion today (Tuesday).
Fearful the collapse of Bear Stearns Cos. Inc. (BSC) would result in a chain reaction of defaults, the U.S. Federal Reserve approved a financing arrangement in which JPMorgan Chase & Co. (JPM) will acquire Bear Stearns for a meager $236.2 million, less than one-tenth its value just last week. The Fed extended a $30 billion credit line to JPMorgan to help finance Bear Stearns’ “less liquid assets.”
The Fed also announced an open-ended lending program for the biggest investment firms on Wall Street, and knocked 25 basis points off its discount rate. The rate at which the Fed lends money to banks directly now stands at 3.25%, a quarter point higher than the benchmark federal funds rate.
“The Federal Reserve in close consultation with the Treasury is working to promote liquid, well-functioning financial markets, which are essential for economic growth,” Bernanke said in a statement. “To that we took two steps today. These steps will provide financial institutions with greater assurance of access to funds.”
Indeed, the situation was so dire the Fed took its first weekend emergency action in almost 20 years just two days before its officially scheduled meeting. And even before the weekend crisis, a wave of weak economic data led many speculators to believe more rate cuts were in store for the Fed.
Payrolls fell for a second straight month in February as employers shed 63,000 jobs, the biggest monthly decline in five years. About 22,000 jobs were lost in January, revised up from the 17,000 originally reported. Retail sales dropped 0.6% in February after a 0.4% increase in January, proof that consumer confidence is waning as payrolls decline and jobless benefit claims swell.
Also obscured by the recent excitement was the Federal Reserve Bank of New York’s general economic index, which fell to -22.2 from -11.7 in February. Readings below zero signal contraction and the March level was the lowest since the New York Fed’s index began in 2001. The index averaged 17.2 in 2007.
“Clearly, the nation’s industrial base is not doing well and the declines in output were fairly wide spread,” said Joel Naroff, President and Chief Economist at Naroff Economics Advisors. “Given all the news about Bear Stearns and the Fed/JPMorgan Chase bailout, this report is the tree that fell in the forest. The reality is that the data support the view that the economy is likely in a recession.”
The Fed will almost certainly announce another rate reduction today. The only question now is by how much. Analysts’ estimates range from 0.50% to a full percentage point. Unfortunately, whatever action Bernanke decides to take, the situation may be out of his hands at this point. [For an in-depth look at the recent market chaos in today’s issue, please click here.]
Rate Cuts Costing the Dollar
The Fed has already slashed its benchmark overnight rate five times since August, taking it from 5.25% to 3.00% in a matter of months. Yet, the economy continues to struggle. The S&P 500 has slipped 11% in that time, and worse, the dollar has slumped an astonishing 15%.
As Bernanke continues to chase plummeting GDP growth, inflation is starting to take root. Consumer price inflation was 4.1% in 2007, its highest annual rate in 17 years. The producer price index rose 7.4%, its biggest jump since 1981.
There has been no improvement so far in the New Year either. The Labor Department’s January producer price index revealed a 1% jump for the month, more than double the expected increase. The consumer price index and import prices were equally dismal. Consumer prices rose 0.4% in January, while import prices increased 1.7%.
Even central banks in Europe have come to recognize the euro as overvalued and are beginning to contemplate action of their own to salvage dwindling exports. The euro hit its most recent record high against the dollar yesterday, climbing to a value of $1.5904.
Overall, the greenback is down 15% against the Canadian dollar, 10% against the Swiss franc, and 24% against the Brazilian real. The dollar also fell below 100 yen for the first time in 12 years yesterday. The dollar is down 10% versus the yen so far this year.
“The momentum is definitely downward for the dollar,” Daisaku Ueno, senior economist at Nomura Securities, told the Associated Press. “With momentum going like this, no one knows where it will stop.”
Excessively low interest rates will only do further damage to the already emaciated dollar by making cash more readily available. Regardless, Bernanke will likely stick to his guns by cutting rates, hoping to encourage whatever growth he can, while insisting a sluggish economy will keep inflation in check.
News and Related Story Links:
- AFP:Fed likely to follow emergency move with fresh rate cut
- Bloomberg:Fed Cuts Discount Rate, Lends More to Avert Meltdown
- Associated Press:Fed Takes Bold Steps to Ease Crisis
- Money Morning:With Bear Stearns Deal and New Game Plan, Fed Raises New Fears About Credit Crisis