Fed Cutting Interest Rate Again?

[Roadtoad]

But in practice, the actual federal funds rate fluctuates slightly around its target as the Fed carries out its open-market operations in the money markets. And because banks and financial institutions have been so frightened about lending in the last month, the actual Fed funds rate has been below 1 percent for the last two weeks. On Tuesday, it averaged only 0.67 percent.

A growing number of analysts now predict that the economy is so weak that the Fed will have to reduce its official target to zero if it wants to jumpstart the stalled economy.

Japan’s central bank reduced its benchmark interest rate to zero for five years, from 2001 to 2006. It did so mainly to combat a particularly persistent case of deflation, a broad-based decline in consumer prices, and to revive economic growth.

Some analysts see signs that the United States faces a similar threat. Like Japan’s, American banks have become so decimated by losses in real estate that they are either unable or unwilling to resume normal lending. And as prices for oil and many other commodities have crashed during the past two weeks, some analysts now warn that deflation might be a threat here as well.

Okay, there's a lot of explanation behind this, but the real problem is that with Chris Dodd and Barney Frank in Congress pushing to deregulate the Housing market, as well as a number of others both within and without the Government, is this really THAT big a surprise? And what does this do to the Dollar on the international markets?

[Gurdur]

The dollar, very oddly, is much immune in the short-term; so many other factors determine the relative worth of the dollar that it is not seemingly affected in the short term (though it might be). The standard thinking is that the lower interest rate may mean more money flowing out to countries with higher interest rates, therefore a lowering of the dollar; but frankly, voodoo seems just as good a shortterm predictor of the dollar's worth as any other theory.

One thing I've noticed from all the journalistic and professional economic commentary; they're very good at explaining trends, but only after a considerable amount of time has passed after the event or trend they explain. They seem to be bloody useless, like everyone else, at explaining what will happen in a month from now.

I do expect the election of Obama to put a temporary bounce upwards into both the dollar and the USA economy; but the "underlying fundamentals" seem markedly against both the economy and the dollar (both which are quite seperate from each other for many purposes).

[Francesca R]

The only sensible economic models (IMO) that have much to say about the determination of exchange rates are purchasing power parity (which means that the differential tradable goods/services inflation rate--between the US and other countries--should influence the dollar) and uncovered interest rate parity (which means that the differential real interest rate--interest rates less inflation--between the US and other countries, should influence the dollar too)

Both of these would suggest that if an economy experiences relative or absolute deflation, its currency should rise, not fall.

Forget about anybody or any stable model "predicting what the dollar will do a month from now". That's virtually impossible.

But in general, as should be obvious, it makes little sense to consider what is happening in the US in isolation (EG not considering the euro-zone, the UK or Japan, or wherever) when wondering what the dollar might do. (FWIW I think that the economies in Europe are in for a worse outcome than the US, partly because of earlier policy dithering.)