Musings on the Fed funds rate cut

The stock market was ebullient yesterday over the Federal Reserve's half-point cut in both the benchmark and the discount rates. But while the stock market loved the idea, it occurred to me this morning that there are some new factors to think about in both investing and how we all spend our money:

• Adjustable rate mortgage owners just got a much-needed break. Much of the credit crunch came from adjustable rate mortgages issued two to five years ago whose rates were being reset. A lower Fed funds rate will make those increases smaller -- and keep some mortgage payers from defaulting on their loans. For all the bluff and bluster about the credit crunch, this one direct effect of the Fed cut is probably the one that will make the most difference to the economy and consumer pocketbooks.


• But the dollar is going down. While the stock market loves low interest rates, this move is going to make the dollar's exchange rate against other currencies drop. An example: the Canadian dollar is already at near-parity to the US dollar; you can expect it to hit all-time highs. And you can forget that European vacation unless you really like to pay $10 for a cup of coffee. On the other hand, for companies like Apple who are just moving their products overseas, lower dollar values will actually boost the profits they reap from international sales.


• Happy days are here again for hedge funds. Many quantitative hedge fund strategies are market neutral: they don't care whether the market moves up or down so long as it moves. For those funds, yesterday's rate cut and 335 point rise in the Dow was an early Christmas gift. And given that big market move generally increase overall market volatility, this one move may put funds back into the black for months to come.


• The Fed just gave private equity carte blanche to resume its acquisition binge. The mergers and acquisitions boom of the last few years was fueled by the gasoline of cheap credit. When the credit crunch hit, M&A activity ceased. Now that the Fed is easing credit rates, expect to see those companies start shopping deals funded with other people's money -- not their own -- again. That means more private companies and fewer public ones.

The bottom line: the Fed just rewound the economic tape back to the beginning of the year. While the credit crunch isn't over, a lot of the conditions that caused it are getting reset. The big question though, is whether investors and institutions will make the same moves -- and engage in the same excesses -- this second time around.

Technorati Tags: Financial analysis, Hedge funds, Markets, Opinion, Private equity, Dollar