There is an old saying in business that it takes a lot of ocean and time to turn around an aircraft carrier (i.e. for change to occur). While the exact amount of time and distance such a task would take is classified, the sheer size of these ocean-going behemoths probably means any such turn would take awhile.
The same can be said for the impact of any FOMC rate cuts, as FRB leaders move the rudder as they try to turn the economy around. The whole problem with the process of moving interest rates is that from the point economic weakness is felt and the first rate cut occurs, it takes about 9 months for the impact to begin to trickle through the economy.
Taking the most conservative position, let's look back in time 9 months to February of this year. Back then, Federal Funds were sitting at 5.25% and nearly everyone believed rates would go higher, rather than lower. Moving along the timeline, we see that the first rate cut of 50bp occurred on September 18th. Calculating the lag time, that means the economy won't feel the benefit of the cut until May or June of 2008.
As one can also see from the grid at the bottom of this page, Federal Funds futures predict rates will go as low as 3.50%, while some economists are even calling for levels as low as 2.00%. To get there, the FRB has some further work to do and if the Futures markets predictions are correct, the impact from the last rate cut would not be coursing through the economy until May of 2009. Clearly, the credit crisis and its spillover effect could take quite some time to clear out and allow the economy to turn.
Despite the Fed's moves late this year to boost the economy by cutting rates, it is obvious we have slipped into a slump and it will take some time to recover. As investors and economists' worry about a lack of liquidity, the potential for stagflation and the accelerating economic malaise, the question everyone wants answered is, "how long we are going to have to suffer until things turn around?"
If the data is correct, it could take awhile. That is because monetary policy is usually considered "easy" only when the Federal Funds rate falls below the inflation rate. With the inflation rate now running at about 2.8%, rates have to fall further before any turn will be completed and we begin to head in the opposite direction.
Given that some economic prognosticators are now saying 4Q GDP will come in below 2% and 1Q 2008 will be below 1%, it appears the risk remains pointed toward the downside.
Since today is "Black Friday," this weekend is a critical gauge of consumer spending strength. As such, rest assured that FRB members will be closely monitoring sales to determine how and when another rate cut may be needed.
At this point in the economic cycle, we therefore continue to suggest community banks model softer growth scenarios in their 2008 budget projections and incorporate a worsening credit environment in the loan portfolio. As Captain Ben Bernanke turns the wheel, we can only hope we won't have to wait much longer for the ship to turn around.