Fed Rate Cut: Too Much or Too Little?

Depending on who you talk with, the answer to that question could go either way.  One thing should be clear; the Fed moves the markets and they can’t help but try to save stocks, just as they appeared to accomplish today.

As I stated in my post, mortgage bonds should be poised to fall, that is unless something like Ben and his Buddies cutting rates unexpectedly occurs.  The markets are full of fear right now, namely fears of a recession, not to mention the global meltdown occurring.  That keeps pushing mortgage bonds higher and higher, even with a rate cut.  That should make you wonder.

In normal times, when the Fed cuts rates, mortgage bonds usually drop and push mortgage rates higher.  This is anything but normal times though.  So, when the Fed cut rates today, mortgage bonds rallied.  That concerns me.

Why?  inflation risks and the fact bonds hate inflation.  Sure, some people say inflation is low, especially core inflation.  Yet, when you look at the last two PCE reports, each ticked higher at the core level, and the last was outside the Fed’s "comfort zone".  The next PCE report is due out next week.  So, is the Fed doing the right thing, or are they out of control?

In my post at Florida Mortgage Report, I talked about something Big Ben mentioned in his speech last week, which was how he downplayed inflation.  His comments were that inflationary pressures should ease this year and next, as long as the public’s confidence in the Fed is not shaken.  I don’t know about you, but my confidence in the Fed has been shaken.  The next PCE report will be key to what my beliefs are because if inflation continues to show growth at the core level, I will have lost all confidence.

The other issue this morning’s decision creates is that of trader sentiment.  While everyone seemed to focus on a rate cut of around .50-.75% at the upcoming meeting, now traders are expecting even deeper cuts next week.  Remember what happened last month when the Fed didn’t cut enough for traders?  The Fed will almost have to do another .25% at the next meeting just to prevent another stock market collapse.

So, what do we have to look forward to?  The Fed will likely cut rates again and bonds will rally, at least until the PCE hits the airwaves.  If PCE shows inflationary growth, bonds are doomed (at least should be).  If not, bonds will likely stay in rally mode and deservedly so.  In the meantime, expect fear to rule the markets creating flight to quality (traders placing money into bonds as a "safe haven").

Oh, I almost forgot.  Those who argue that inflation is in check must not be watching the dollar.  If the Fed keeps devaluing the dollar, something rate cuts do, then there is inflation, even if we don’t see it here in the US.  Any time our purchasing power is diminished, inflation exists, and that can be seen in the currency markets.