Finance Weblog: The unwanted Fed cut - Instituto de Empresa Business School

The Fed cut rates yesterday by 25 basis points as markets has correctly priced. The statement from the Fed is clear with a few important messages. According to the statement:

a) This cut together with the previous one in September were designed to “help forestall some of the adverse effects on the broader economy” from the credit crunch.
b) Sees intensification in housing downturn.
c) The Fed sees “the upside risks to inflation roughly balance the downside risks to growth."
d) “But recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation."

Summarizing, the Fed believes the combined cuts of September and October will help easing credit conditions. But more importantly they need to watch carefully inflation increases, specially taking into account recent movements in oil. The statement sends a message to markets that this is the end of a brief easing cycle that was initiated just to grease the wheels of credit markets.

However yesterday´s decision has not been taken unanimously. Hoening , President of the Federal Reserve of Kansas City voted against the cut. This is the first time over the current year that the rates decision has not been unanimously taken. This is just a reflection of two differing views on how to deal with current conditions: on the one hand those that think that the credit squeeze will/should need a harder push from the Fed and on the other hand those who think that the Fed is permitting a built up in future inflation.

On the communication front many believe that Fed has been carried away by markets pressures without been able to communicate neatly. Blinder, from Princeton supports this view. According to professor Blinder:”The Fed did not make their views very clear to the markets for about a three-week period in October when they could have. As result, they wound up being pushed by the market. The Fed has a communications problem when the market's thinking diverges from the Fed's and the Fed doesn't say anything to get [the two] back in line."

Yesterday's statement is attached below.

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