Global Coordinated Rate Cut

The US Federal Reserve along with the Bank of Canada, Bank of England, the European Central Bank, Sweden Riksbank and the Swiss National Bank acted in concert to reduce short term lending rates in pre-market hours this morning.

By a unanimous decision the Fed lowered its target rate for the federal funds rate by 50 basis points to 1.5% and reduced the discount rate by an equal measure to 1.75%. While it is certain that the FOMC did not respond to the overnight deterioration in interbank markets, the move comes at a crucial time and almost certainly was taken in support of the series of unprecedented moves taken in recent days by the Fed and its global partners.

We have made the case in recent days that a global central rate cut was in the offing and we do think that the steps taken by the Fed, the Treasury and the Congress should facilitate the movement in overnight and short term lending. Should this occur, holders of adjustable rate mortgages that reset based against the six month Libor rate, which has increased over 100 basis points over the past month, should see some relief. This small, but crucial point should prevent further deterioration in the value of the illiquid mortgage assets held throughout the global banking system.

In recent weeks we have observed a trend in the macroeconomic data, which indicated a clear decline in industrial production, wholesale-retail sales and expect a reduction in demand from the external sector. While, some measure of inflation is embedded in the economy, the deflation in the residential real estate sector and the clear decline in the cost of energy and commodities paved the way for the Fed to take what may be the next in a series of continuing steps to stem the crisis in financial markets. Moreover, when we plug in the likely fall in the core rate of inflation and the increase in the rate of unemployment into our Taylor Rule model, the Fed is getting out ahead of the curve and moving towards the point where rates are neutral.

Given the near meltdown of the domestic system of finance we think that the Fed needs to compel banks to come clean regarding the wreckage littering their balance sheets, provide a temporary guarantee of the payment clearing system and in the near term move to inject capital into the banks. The conditions have been created where by those steps can be taken.

Axel Merk Chief Investment Officer and Manager of the Merk Hard and Asian Currency Funds
http://www.merkfund.com/

The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice nor considered as an offer to sell or a solicitation of an offer to buy shares of any securities mentioned herein. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard Currency Fund. Foreside Fund Services, LLC, distributor.