Conundrum! The Fed will cut. It's the only option. Congress will deal with the pain of the
lower dollar. Watch and Learn. If you second guessing this situation you will miss this
commodity move.

Last edited on: 09-11-2007 12:13 pm

I would take issue with the assumption that a fed cut would cause a disorderly unwinding
of the yen carry trade, as I think you are overestimated the amount of treasuries (since
the yield's mediocre at best) that were bought using this strategy. However, I would be a
seller into any rally spawned from a rate cut and guess that there would be some
uneasiness about future growth given how fed cuts were unable to prevent a recession in
the early 2000's.

While i agree with what you are saying Sarah, the effective Fed funds rate is already at
5% (roughly). So, to me, the effect of a 25 basis point rate cut is more psychological
than financial. As for China and Japan, I think they will lighten up (evidence already) on
their investments but the dollar has never declined four years in a row on other major
currencies (this is actually true of all major currencies). If they are holding this for
long term security of their money then they shouldn;t be sweating it as much as a 30%
decline would have us believe. Also, don't you think the market has priced in a rate cut
in the dollar already?

So Uncle Ben is in quite a fix. . . He can do nothing that will not make things worse.
He's GOT to be the most ALL-ALONE MAN on the planet. He's desperately looking for a way
to save the financial system without demolishing the markets and the economy.
Unfortunately every choice he has, cut, hold or hike, is equally bad. And he's fresh out
of rabbits.

While all of this is true, there are several reasons why the Fed cannot cut rates. These
reasons actually cascade into each other:

1) Lowering rates while the dollar is at 15-year lows would rive the dollar lower.
2) A lower yield on Government paper would work as effectively as a rate hike in Japan:
Force a disorderly unwind of the carry trade. Since the collateral used to short Yen has
blown up, this would force a precipitous sell off in equities.
3) A lower Dollar would put the largest holders of US Treasuries, Japan and China, in an
untenable situation. They have already seen their investments decline in value by 30%
this year just on the exchange rate. How much more pain can they endure before dumping
Treasuries for gold?
4) A collapse in Treasuries removes the last safe haven and foreign investors flee.

We're a whole lot closer to the edge than anyone thinks. US banks need a rate cut.
Foreign banks need the Dollar to stabilize.

The problem is that the banks know what kind of crap is on each other's books. They don't
want to lend to each other, or to anyone else for fear of making a bad loan. They will
only lend at high rates. The credit spreads are the proof. Look at the spreads on
commercial paper. This is why the Fed lowered the discount rate. At the time, the credit
markets were on the verge of completely siezing up. Now the credit markets are flowing
like 30-weight in a Minnesota winter, but the system is working (barely). The arguement
for the rate cut has nothing to do with saving homeowners. It's to save the banks. A
rate cut would allow the banks, which are leveraged 10:1 and as such extremely sensitive
to interest rates, to lend again, an loosen up the credit markets.

(more. . .)

Read the constitution and the Fed Act of 1913.

i dont think jim answers very many questions on the forum he tends to only respond to
questions posed in the questions section.

Jim, if the interest rates on the adjustable rate mortgages are going to reset higher in
the next 12-24 months as everyone agrees, why does the fed need to lower rates NOW!! It
would seem they could lower rates in 3 months and the mortgages that are affected will
still be adjusted lower?