A Funds Rate Treadmill
Jude Wanniski
January 2, 2001


The bad news the market is now absorbing is that contrary to almost universal opinion, "monetary ease" that simply involves a lower fed funds rate will have no effect in halting the inexorable consequences of the monetary deflation. Only additions to liquidity over and above market demand can do that job, and nobody is talking about doing that. Indeed, as the market prices in a lower and lower funds rate, the demand for liquidity increases faster than liquidity is being supplied, which explains the fall in gold today. "Stimulative" actions taken are thus perverse.

Here is the comment from our Mike Darda on today's action:

"Fed funds futures now are pricing in a full 100 bps in cuts by June -- with 50 bps coming this month. The entire yield curve is posting big gains today, with the 30-year rallying by 10 bps. It's not totally implausible that the Fed could reverse the entire May rate hike of 50 bps in one swoop. That's probably what the bond market is pricing in now. The million dollar question is whether gold will continue to fall. If gold does continue falling (it dropped by $5 today alone) real interest rates will not come down and the Fed will find itself on a reverse treadmill. For the bond market, that probably means additional gains, especially in treasuries and high-grade corporate issues with low default risk. But rate cuts won't necessarily rescue equities or junk bonds if gold continues to slump, causing real interest rates and credit/default risks to stay at stratospheric levels."