Today the Federal Reserve cut the rate by 0.25%, the first cut in 11 years. They did this a half year after they raised rates when they said there was a need for more tightening. Rate cuts are not that useful and lack substantial impact on the economy. Most borrowing is done with short term or intermediate term debt which may be fully amortized over a few years, thus the principal payments as a percentage of the total payment are quite high, so a tiny 0.25% cut in the rate (tax-deductible for business and many homeowners) is a very tiny portion of the total payment.
If a business manager is worried there will be no demand for a new factories output, then cutting the rate won’t motivate him to expand the business. Cutting rates mainly fools naive low-income consumers who don’t have any spending capacity, so rate cutting is of dubious value. Fed cuts are short term and can be capriciously taken away, thus no one should sign up for a major debt financed purchase of an asset like a factory or a house if the supposed rate cut can be a brief temporary tease that can be quickly eliminated. Consumers know this, so they don’t respond anymore than they did during times of inflation when a person receiving a pay raise would discount it for inflation and taxes and then decide they were really no better off and they simply discounted the raise back down to zero and thus reduced the growth of their consumption.
The one place where a short term temporary rate cut can be used is in speculation where investors get a margin loan to buy stocks and if the rate goes up they sell the asset and payoff the loan. But buying of already issued stocks (the Secondary market) doesn’t help the economy, it puts no new cash into the hands of companies, it merely enriches speculators who may simply roll over their winnings instead of using cash to expand the physical economy.
The way the Federal Reserve can be useful and effective is by acting to minimize confusion or speculation and by acting as a standby to the government when Congress implements fiscal policy by monetizing the Treasury debt during genuine emergencies. The Fed should not monetize Treasury debt during routine, economy stable periods of rising deficits.
Most likely a recession will occur in 2020 and the Fed will cut rates to zero to match the rate of other countries, but that won’t overcome consumers’ objections and thus won’t result in a booming economy. The danger is that to an increasing degree consumers and business will lose confidence in the Federal Reserve and this could create a self-fulfilling prophecy as people learn reflexively to distrust and disregard the Fed’s stimulus programs.
I believe rates in the marketplace are low mainly because of the market’s Invisible Hand worrying about the risk of a future depression and because of a growing trend of foreign EM flight capital coming to Developed countries that creates a surplus of bond buyers thus raising bond prices/cutting yields. Despite the scary data of the huge global QE, the Fed’s QE and rate cutting may have only lowered U.S. “AA” rates by 0.5% or some say, by 0.85%. The real reason for low rates is because something is (both currently and in the near future) wrong with the global economy and there is no known solution other than gradually muddling through by trial and error.
The global economy is hurt by cheap EM labor, a flood of EM flight capital to Developed countries, excessive capacity in many countries that use reckless “policy” bank lending with no underwriting, to create overcapacity in factories. These were hard/impossible to do in the era before modern telecommunications, jet travel, etc., so the problem is at a new, unprecedented scale, thus the market discounts risk of depression and imposes a sovereign (“A” or higher Investment Grade) bond yield near zero on a global average.
This is not the time for the Fed to try to fool people with a superficial placebo of petty rate cuts. Instead Congress should implement regulatory and tax relief aimed at encouraging businesses to move to the U.S.
Lowering rates hurts retirees who live on bond yields, thus pushing them into a depression, thus cutting their consumer confidence and reducing demand for goods. Thus QE is a self-negating act which, when ultimately correctly understood, makes the Fed look unwise and thus destroys the Fed’s credibility, thus further contributing to being stuck in a deflationary trap.
Investors need independent financial advice.