Where Has the Exuberance Gone II?

Clearly, I spoke too soon. The exuberance is not gone from the market, it is in fact being stoked by the Fed ("Cheering Greets Fed Announcement"). I find myself to be a rather curious situation. I personally want a significant interest rate cut because it will be good for my portfolio, but I am against it in principle. I am probably not the only one feeling really mixed here. Even as the markets record the highest one-day jump in years, 2/3 of Financial Times readers are against the half-point cut.

Poor Growth or Poor Policies?

Over the past decade, the Fed has given the impression that it fears economic slowdowns more than it fears bad policies - a willingness to stomach all kinds of economic imbalances to promote growth. In 1998, it cut interest rates and organised a bailout on LTCM. In 2001, it slashed interest rates aggressively to contain the fallout from dot-com bubble.

Listen to what the Fed actually said - "Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."

The disruption in the financial markets stemmed from the burst of the US housing bubble, a real problem created by excessively low interest rates and excessively high liquidity. Yet, in a reverse of logic, we are now hearing the Fed say that the interest rate cut is necessary to prevent the financial markets from hurting the real economy.

Whatever the problem, the solution is always the same: interest rate cut (the so-called Greenspan Put). It does not matter what the root of the problem is, such as excess liquidity in the housing sector. The Fed solution is always the same - more liquidity to ease a problem created by excess liquidity.

I am neither monetary economist nor central banker. But a Fed that has lost its stomach to take an economic slowdown is increasingly one that the markets have no respect for.