As we all saw on Wednesday, the Federal Reserve made equal 25 basis point cuts to the Federal Funds Rate and the Discount Rate. While we are happy that core inflation is not going to be a large problem with this rate cut, and that we are easing rates in a growing economy where we just saw the U.S. economy grow at an annualized growth rate of 3.9%, I believe that many other problems will arise.
While lowering rates will bring along a lower borrowing cost I do not think that our economy needs this. Doing this will only bring people to spend more money on things they do not need. As we saw already companies that sold necessities like The Procter & Gamble Company(NYSE:PG) and Johnson & Johnson(NYSE:JNJ) have both been doing well though the subprime market problems.
Lowering rates now will also bring problems to the dollar and eventually make everyday products more expensive. This problem will arise in the future because with lowered rates the USD will keep depreciating. The Euro, Canadian Dollar, and the Yuan have all made decent gains over the past months against the US dollar, and will continue this appreciation with lower rates in the US. The weak dollar will also hurt oil prices and we now have the potential to see $100 a barrel oil prices in the near future. This means that if your heating your house with heating oil you going to be paying more then you’re used to seeing.
Bailing out the market by lowing rates is not a cure right now; it is only putting a band-aid on the problem. Lowering these rates is also telling reckless investors and subprime borrowers that the Federal Reserve will always be there in times of worry. These problems will not disappear by just pouring more money into them. Another big problem that arises when lowering short-term rates is that it hurts long-term rates. While giving people who have adjustable rate mortgages and lower reset price, people who can afford long term fixed mortgages are going to be paying higher rates. These continuous rate drops may only be feeding more problems to come in the housing market.
All we can do now is wait to see what the outcome is of these rate cuts. Often it takes months for our economy to realize the effects of multiple rate cutes. For now watch commodities closely as they are often a hedge against the stock market in periods of lowering rates.