Earlier this month, central banks around the world—including the Federal Reserve—trimmed rates by half a point in a joint effort to encourage lending and thaw a frozen credit system. On Wednesday, the Fed announced a second cut of 0.5%, reducing the Federal Funds rate to 1%.
In the Fed’s statement Wednesday, the central bank indicated that rates could possibly go lower sometime in December, especially if the “downside risks to growth” persist and the U.S. economy continues to lose steam.
It’s too early to tell if this latest round of cuts will make any real difference to facilitate lending, but luckily these reductions are just one tool in the Fed’s bag of tricks. The bottom line is that the market responds well to rate cuts, as we saw in the 900-point run-up in the Dow the day before the FOMC’s big announcement, and the 250-point upswing just after the statement was released.
The Commerce Department released a report today that said consumer spending fell 0.3% in September. This news comes on the heels of another report that indicated belt-tightening consumers drove spending down in the third quarter by the highest rate in three decades.
This was to be expected, especially since layoffs are rising and it’s harder for consumers to get their hands on credit!
Since consumer spending accounts for 70% of total economic activity, it should come as no surprise that the third-quarter GDP estimate reflected a 0.3% contraction. Although this figure was better than economists had expected, it’s a strong indication that the U.S. economy is falling into a recession.
The outlook for greater spending in the near-term is bleak, and retailers are already bracing for a tough holiday season. Unless spending improves, the “R-word” could come to fruition. It’s a double-edge sword because it makes perfect sense that consumers would want to save money when expectations of a recession are widespread. But at the same time, the lack of spending sharpens the downturn.
A week ago, Fed Chairman Ben Bernanke hinted at a second stimulus program. It’s too soon to tell what form such a package might take, especially with the presidential election in less than a week. Like many policy decisions about the current economic crisis, any bailout package will have to be finalized after November 4.
Perhaps the most important aspect of the upcoming election is that the results will remove a tremendous degree of uncertainty from the markets. Investors will finally know once and for all who will be the next president and which economic plan will take hold.