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Federal Reserve cuts 25 basis points, dropping the US interest rate to 4.50% – October 2007

Posted by Adrian on November 1, 2007

The US federal Reserve continues to cut rates. The federal fund now sits at 4.50%, from 4.75% with a cut of 0.25%, the discount fund rate that banks can borrow from has now been cut to 5.00% from 5.25% also with a cut of 0.25%.

It could be argued that the American economy is already in a growth recession with a full blown recession on the cards, with the next two quarters of GDP growth into 2008 being the deciding factor.

“But the third-quarter report is like looking at movie flashbacks. It is the growth in the next two quarters where the rubber meets the road. Analysts expect growth in the fourth quarter to slow to around a 1.5% rate, less than half of the third quarter. They call the January-March quarter of 2008 “the dangerous quarter” for a sharp slowdown.

“What generally happens in a recession is that the economy starts to slow down, and then growth just falls sharply. None of the complex econometric models in use can forecast this break.

‘Most of the models are continuous, where the economy strengthens a bit or softens a bit. It is quite difficult to deal with what could be a step-change, where you get some tipping point where everyone decides it is time to cut back on hiring and capital spending. When that happens, pretty soon everything snowballs into a major slowdown, ‘ said Nigel Gault, economist at Global Insight.” MarketWatch: Can the U.S. economy pull an Indiana Jones? Danger of recession looms, with early 2008 seen as most treacherous period

A fed cut does nothing but stimulate the stock market and ease fears on Wall Street, but home owners who are defaulting on mass get no real reward from a 0.25% fed cut. Maybe an illusionary feel that rates have come down (even though most mortgage rates are adjusting upward) and the American economy is ‘healthy’ again (apart from the housing mess) but inflation picks up. The good indicator for US inflation is the American dollar, which is being dumped for higher yield currencies, the USD continues to plummet against the Euro, AUD, NZD and most Asian currencies. A declining USD isn’t good, with China’s economy growing and their Yuan appreciating at very slow pace, overinflated currencies like the AUD and EUR (due to carry trading and investing) – so if the USD doesn’t regain some strength it may get unpegged by Middle Eastern and even some Asian currencies, which may lead to complete meltdown of the USD. This could throw the world into a currency crisis.

Regardless of the US slipping into a severe recession and it’s possible negative effect on the world economy. High oil, high food costs, namely wheat is going to inflate food prices throughout the world. The northern and southern hemispheres have both had droughts, with Australia (a wheat exporter) having gone through one of the most severe droughts in history. So inflationary pressures in Europe will continue and a resonating credit crunch from the sub prime mortgage disaster in the US, will inevitably lead to consumer’s paying more for food through to banking products (wordwide).

The banks have all suffered from the credit crisis. The biggest write-downs have come from Wall street, namely Merrill Lynch with a huge $8.4 Billion write down on the brokerage firms exposure to subprime debt. Other investment banks and brokerages have been Citigroup $6.5 billion loss on fixed income trading related to the subprime mortgages, Swiss bank UBS AG loss at $3.5 billion, Bear Stearns closed down their hedge fund after losing $1.5million, with Bear Stearns also losing $700 million on it’s exposure to the subprime mortgage markets. Overall the global banking sector is still spooked from massive losses from both retail banks, investments banks and other big financial industries including insurance companies.

But the debt bubbles continue to grow, if confidence returns to the American consumer, it will be on the back of credit, can employment hold into 2008? What ever the case, the collapsing housing market, the ongoing inflation with food and oil and a banking sector that will pass on costs to consumers will all have a negative effect on the largest economy in the world.

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One Response to “Federal Reserve cuts 25 basis points, dropping the US interest rate to 4.50% – October 2007”

  1. […] by zekukith on November 19, 2007 With the American economy going into a recessionary down-slide. The Federal Reserve has cut interest rates and will continue to do so, which has caused the plummeting value of the dollar. With America […]

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