Fed Rate Cut Not A Magic Bullet

Federal funds rate cuts aren't magic bullets for the economy, say a number of pundits -- so many in fact that magic bullet may be replace housing bubble as the most overused phrase in finance.

CNN's Gerri Willis said so Halloween, after the Fed's overnight borrowing rates were cut for the second time in a month.

Chris Rupkey, senior financial economist at Bank of Tokyo (New York) told Bloomberg the same thing on November 26, 2007. "Given the heightened state of credit aversion going on it looks like the only magic bullet that they have to help the markets is a rate cut," Rupkey said.

Even bloggers love the phrase. Remarking that investors "really love rate cuts," blogger Darren on the Superiorinvestor.net blog, says, "They must think a rate cut is some sort of a magic bullet for the economy, because every time they hear about one, they get giddy with excitement." Homebuyers get giddy over Fed rate cuts, too, because they think that Federal rate cuts directly influence mortgage interest rates. Sorry to disappoint, but mortgage interest rates typically go up after a rate cut, not down. Mortgage bond investors want to make sure that the most recent rate cut hasn't ignited inflation so they tend to hedge by moving their money to stocks.

The Fed cut the federal funds target rate to 4.25 percent this week. What that means is that banks can borrow short-term money from each other at a recommended rate. Because the Fed can't dictate what happens in the open market, it will issue a "target" rate for federal funds, which most banks stick close to. The banks can then charge consumers whatever they feel they can get away with as much as the market will allow in credit card interest rates, mortgage interest rates, car loans and so on.

Not surprisingly, interest rates are up, because investors are anticipating inflation.

So if you're a homebuyer anticipating interest rates to go lower than the nearterm record lows we're seeing now, you might be in for a long wait.

Fed cuts may not be a magic bullet for the economy or housing, but at least no one's saying there's a housing bubble anymore.

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