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Five Things You Need to Know: Fed to Cut Rates


But so what? The reality is that the Federal Reserve no longer has any control over short-term interest rates.


Kevin Depew's Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Fed Week

Tomorrow, December 16, the Federal Reserve Open Market Committee will meet and probably announce an additional 50 basis points reduction in the Federal Funds Target Rate, which is the Federal Reserve's preferred or "targeted" rate at which banks lend to one another overnight.

But so what? The reality is that the Federal Reserve no longer has any control over short-term interest rates. A different question is whether they ever had control in the first place, or whether it was merely the appearance of control, but we'll leave that for another time.

Below is a chart of the Fed Funds target rate (the rate the Federal Reserve would like for short-term interest rates to be set) overlaid with the effective Fed Funds rate (the rate at which the Fed Funds is actually being set by the market place).

Fed Funds Target and Effective Rates
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2. Do Your Homework: Preparing for Future Fed Policy

Among the most frequent complaints coming from money managers and traders these days is that the seemingly ad-hoc policy pursuits by both the Federal Reserve and Treasury Department make virtually every trading day a free-for-all. No one really knows what bizarre policy tweak will come next. So what do we do?

I'm reminded of that scene in the movie Patton where General George S. Patton, believing he had successfully defeated General Erwin Rommel in the North African desert, smiles to himself and exclaims, "Rommel, you magnificent bastard, I read your book!"

If we want to know how the Federal Reserve and Treasury will respond to the ongoing economic crisis, we can start by reading, "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment", Ben S. Bernanke, Vincent R. Reinhart, and Brian P. Sack, 2004.

From the Abstract:

"The success over the years in reducing inflation and, consequently, the average level of
nominal interest rates has increased the likelihood that the nominal policy interest rate
may become constrained by the zero lower bound. When that happens, a central bank
can no longer stimulate aggregate demand by further interest-rate reductions and must
rely on "non-standard" policy alternatives
. There is some evidence that central bank communications can help to shape public expectations of future policy actions and that asset purchases in large volume by a central bank would be able to affect the price or yield of the targeted asset."

Well, so much for central bank communications being able to shape public expectations. We now know that's not true. But the part about "asset purchases in large volume by a central bank"? We'll soon find out.

3. More Auto Pressures

The pressure on the auto market is increasing. The Manheim Used Vehicle Index, which tracks the wholesale and retail used auto marketplace, fell another 5.7% in November on the heels of October's record 6% drop. The decline is now 12.2% year-over-year.

As Manehiem noted on their Web site, while the prices may appear to be "bargains" on the surface, there are no bargains if there is no retail demand.

Meanwhile, Capital One Financial (COF) said in a regulatory filing today that car loan delinquencies rose in November from the previous month, with 9.5% of total auto loans now delinquent. That's up from 9.1% in October. The company is aggressively managing its portfolio of auto loans and dramatically cutting back new loans, all of which feeds into weaker demand and lower prices.

4. Speaking of Autos, Special Devices Files for Bankruptcy

Speaking of ongoing auto woes, today a 50-year-old automotive components manufacturer, Special Devices Inc., announced it is being forced to seek bankruptcy protection after failing to refinance a little over $70 million in debt.

According to Bloomberg, at least 11 auto-parts manufacturers have filed for bankruptcy protection this year... and that's all with General Motors (GM), Chrysler and Ford (F) still in business.

5. Feds to Rein In Credit Cards?

While all eyes for the next two days are on the Federal Reserve's FOMC meeting, many may be surprised to learn that's not the most important decision coming out of the Fed this week. The Federal Reserve on Thursday will vote on what could potentially be sweeping changes to the credit card industry, including banning the practice of retroactively raising card rates and eliminating some late fees and penalties.

Meanwhile, to discuss this important topic we turn to another Minyanville Edition of Point/Counterpoint. This edition looks specifically at whether you should carry a credit card balance.

Point/Counterpoint: Should You Carry a Credit Card Balance?

Carrying a Credit Card Balance Is No Big Deal

By Carrington Potter Brown-Huffington

I confess. I carry a credit card balance each month. But it's not what you think! My husband, Ashley, and I have sterling credit, and therefore pay only a low, low super-platinum prime annual interest rate of 1.99%. We carry a credit card balance each month, but instead of working to pay that balance down, our balance works to pay us!

How does that work? Let me explain.

We typically borrow against one of our platinum cards with a $400,000 limit, and reinvest the money in a higher-yielding money market account that pays 4.5% interest, therefore earning a convenient spread. Isn't it wonderful? And think of the frequent flier miles we earn! One mile for every dollar used - $400,000 limit? You do the math!

Last March we flew to Tuscany - just to visit a little vineyard we own there - and the airfare was entirely free thanks to the mileage we earned while using one of our credit cards. Plus, we used the money we earned on the spread to finance the entire trip. Essentially, our credit cards pay us to travel! Isn't it marvelous? Why work for your money when you can make your money work for you?

That's Strange, I Mailed in That Payment Weeks Ago

By Eric Jones

So you didn't get the check, huh? That's really strange, because I mailed it in weeks ago. Priority mail too. Wow. Weird. The worst part was that it was for the full $28,454.72 MasterCard balance. No, I understand completely. You're running a business. Ok, so... huh... I'm just trying to figure out what to do here. Should I overnight another check? Because I could do that. Or how about this. Just hear me out for a minute. How about you guys go ahead and just, I don't know, just maybe turn the credit card back on... wait, just, just let me finish... so you guys would turn the card back on so I could use it for, uh, my business, and then I would send in two checks in two separate envelopes, one for the whole balance, the whole thing, $28,454.72 and... ok, right, with the late fees and extra interest that would come to $29,103.56, OK, no problem, just writing that down on the check right... now... so I'll send in this check here in my hand right now for the whole balance and in an entirely different envelope I will send in what we'll call a "Safety Check" for the minimum payment of $45... you know, just in case the check for the whole balance gets lost again. Haha five times! Five times that check has somehow disappeared at the post office. What do those people do down there, throw the credit card payments in a special box and burn them? Haha. Oh, OK, no, I understand. Then I'll just go ahead and send in a check and when you get it you can turn the card back on.

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