Thursday, December 6, 2007

Is A Rate Cut Really A Sure Thing?

For some reason I just am not in the 50 point cut camp like most folks are. As a matter of fact, as I speculated last week, I am not even sure I think a 25 point cut will happen.

Why? Today's reports show the the current economic situation is not nearly as dire as people think.

Productivity in the nonfarm business sector increased at a 6.3% annual rate in Q3 the government said in its second estimate of productivity. A month ago, the government said productivity rose 4.9% annualized.

Unit labor costs, a key gauge of inflationary pressures from wages, were revised much lower, showing a 2% annual decline in the third quarter compared with a 0.2% drop estimated a month ago.

Unit labor costs in the second quarter were also revised much lower, from a 2.2% gain to a 1.1% decline, reflecting more up-to-date compensation information. The revised data show inflationary pressures from tight labor markets are much milder than previously believed.

Now this does give the Fed room to move rates lower and relieves the worry that inflation may spike. But, with the economy going at a healthy pace, are rate cut really even necessary?

Consider today jobs report.

Private payrolls grew by 189,000 in November following a revised 119,000 gain in October an ADP report said today. The increase was well above expectations for job growth of only 60,000 in November.

Employed workers are spending workers. Now, much of the rate cut talk has been focused around mortgages. The simple explanation was that millions of resets of adjustable rate mortgages were coming and high rates woulds cause high resets and million of foreclosures. The argument was that lower rates would help mitigate that. Word today is that Treasury Secretary Hank Paulson is working on a deal to freeze resets for 5 years. If that happens, then we now know the scope of the problem out for the next 5 years. We can assume based n historical data what will happen in the mortgage markets with some degree of accuracy.

If we know the scope of the problem, the impetus to lower rates to stave off a catastrophe is now gone. With that being gone, we now go back to the old fashioned reason for rate cuts, growth vs inflation. Right now, both seem to be just fine and if they are just fine, is there really a reason to tinker with rates?

While I do not feel a cut is necessary, with the market 100% sure a 25 point cut is coming, I would assume Bernanke gives it to them if for no other reason that to avoid an end of years sell-off.

Should he give them 50, the only thing that would justify it would be an accompanying statement saying the Fed is essentially "done" unless things "dramatically deteriorate". Either way, Tuesday will be one hell of a day

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