Personal Finance Advice

Economists were surprise on Friday when the Labor Department released inflation figures for the month of February.  The Consumer Price Index remained unchanged for the month after it was expected to rise by 0.3 percent.

The report could open the door for a full percentage point rate cut when the Fed is scheduled to meet on Tuesday.  Futures traders had been betting on a 75 basis points cut but many were increasing their bets for a full point cut after the report was released.

However, inflation is still a concern, with oil trading above $110 a barrel and gold breaking the $1,000 an ounce mark for the first time ever.  The fact remains though that with core prices remaining virtually unchanged, it does allow the Fed to act more aggressively in it’s policy initiatives in the near future.

The situation in the credit markets may force the Fed to do just that.  On Friday, the Fed along with JPMorgan moved to provide emergency funding for Bear Stearns Co., preventing the imminent collapse of the nation’s second largest underwriter for mortgage backed securities. 

It was a break in tradition for the Fed, which normally doesn’t interact with non-traditional banks in this manner.  However, desperate times call for desperate measures and the collapse of the investment bank would have sent shock waves through the entire financial sector.  With many firms struggling in a ever worsening credit crisis, the Fed may have to act again in the future to prevent the failures of other financial institutions.

There is a fear that this is a bad precedent being set, that firms can invest irresponsibly, only to hold out their hands to the Fed in their times of need.  Nonetheless the Fed had to act in this case because the alternative would have been unthinkable.

Monday saw the stock market hit a two year low, but what a difference a day makes.  Stocks surged 3 percent for their largest gain in nearly five years after the Fed announced plans for a new $200 billion securities lending program that directly infuses liquidity to twenty of the nation’s largest lenders and investment banks.

Wall Street loves this move because the Fed is offering to accept as collateral, mortgage backed securities, in exchange for Treasury securities which banks will then be able to resell on secondary markets for cash.  Basically the Fed is almost acting as a buyer of last resort, providing a market where none exists.

Whether this plan is large enough in scope remains to be seen but it is a step in the right direction.  Another positive note is that the Fed was able to coordinate this move with other central banks in Canada and Europe, who also plan to inject their banking systems with liquidity, albeit at a much smaller scale, approximately $45 billion.

This move also takes some pressure off of the Fed, whom many have been calling for an emergency rate cut ahead of their regularly scheduled meeting next week.  The futures market is predicting a 75 basis point cut after that meeting.

While this is a nice short term fix, that’s all it really is.  The Fed would prefer that banks lend each other money but right now they don’t trust one another.  The problem is no one wants to buy securitized debt. 

The whole point of securitized debt is to provide short term liquidity for an asset that is illiquid in nature, like a long term loan.  Credit markets are in shambles because banks are stuck with all this debt that they either can’t sell or if they can, at seriously discounted prices.

As it looks more and more likely that the economy will enter a recession in the upcoming months, many Americans are wondering how bad it will get.  The root of our current economic troubles, the housing market, continues to grow worse.  Housing prices fell again last month as an increase in foreclosures adds to the glut in supply in the market.

The economy lost jobs for the second month in a row as stocks fell to their lowest level in nearly two years.  The Labor Department reported that 63,000 jobs were lost for the month of February following the 22,000 in losses for January.

The Dow fell under for 12,000 for the first time since August of 2006 as bad economic data and high oil prices sent stocks tumbling.  Earlier in the week oil rose to over $105 as OPEC announced it was maintaining it’s production at their current levels.

Energy prices are expected to continue rising, but how high can the price of oil go? Some analysts are saying $120 but there are others who say it could top $150 by the end of the year.  European Central Banks announced this week that they were not cutting interest rates and futures traders are now betting that the Fed will cut rates by 75 basis points later this month.  This will put enormous downward pressure on the dollar in exchange markets and force the price of dollar denominated assets like oil upwards.

The high price of oil is starting to take it’s toll on consumer spending as well.  It is estimated that every $1 increase in the price of oil costs Americans an extra $100 Billion a year.

Amidst all the gloomy economic news is the specter of inflation.  The Fed has had no choice but to put it in the back burner as it slashes rates in an effort to keep the economy from stalling.  As the credit crunch worsens it has had to pump more and more cash into the money supply to compensate.  This week it announced it was making in as much as $200 billion more available to banks as it increased it’s Term Auction Facility amounts from $30 billion to $50 billion.

There is a real threat that we could be entering into an era of stagflation that could last for quite a bit.  I would say that until the housing market starts to improve, we really have no idea how long this economic downturn could last.