Fed Cuts Rates to 1% to Stave Off Worldwide Recession

As expected, the Fed today dropped rates by 50 basis points (half a percent) to 1%. Rates have not been this low since 2003, when the Fed, scared of deflation drove rates down to 1%. Of course, we know how that ended - with the popping of the largest housing and credit bubble the world has ever seen.

In its statement, the FOMC said:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.

The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.

Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

The idea is to make it cheaper for banks and borrowers to get money. That should lead to more lending and thus help stimulate the economy. The problem is that banks still don't want to lend and consumers don't have the cash to borrow. In the 1990s, Japan cut its discount rate to 0% and it still couldn't jump-start lending. As the chart below shows, consumers are tapped out, and until they can bring their debt loads down to historic levels, they will be unable to take on new credit. That's especially true because banks are no longer willing to lend money without regard to whether or not a person can pay the money back. That marks a seismic change from just a year ago.

Of couse, the real losers in all of this are the savers, who will now undoubtedly see the interest paid on savings accounts, money market accounts, and certificates of deposits decline. Competition for deposits has actually kept savings and money market rates relatively high, but we're already hearing from banks that rate cuts are coming.

You can still get a wide variety of CD (certificate of deposit) terms with rates above 4%. I'm not sure how much longer that will last. Analysts are talking about additional cuts below the 1% but that seems premature. Fed Funds Futures currently give the highest probabilty to rates staying at 1% through December.