Jan 30, 2008

Is Fed Funds target rate a market indicator

Jim Cramer has a push button that yells out "they know nothing", and Cramer uses that button many times for Fed's interest rate cut decisions. Don't Feds really get it? Before I opine on that, let us see how has Fed s fund target impacted S&P 500 index in the past. So I plotted Fed Fund Target rate against S&P 500 starting from Jan 1998 till Jan 2008. Below is the chart.


What all did you notice in the chart? Here are what I found:

1. Feds did not act immediately in September 2000 when S&P 500 started falling. It took them around 3 months to start cutting the fed fund rates.

2. In 2001, while the feds were cutting interest rates, the S&P 500 was still falling. This went on for almost 2 years until the fed kept the fed fund rate flat steady at 1%.

3. Does this chart also say that the Fed fund rate will have to stay flat at the lowest level for a while before S&P 500 can move up? I think once the market shrugs off the bad news, the fed will wait for few months to move the rates upwards.

4. The Fed fund target rate moved up after S&P 500 is well off the bottoms, around mid 1004.

If the above observations are any guidance for the currently ongoing recession (or Slowdown if you want to call it that way), we still have not seen the bottom in S&P 500. The feds are still cutting fed fund target rates and they are willing to cut further if needed. Currently we are still in the down slope for fed funds rate and the S&P 500 can still slide downwards. From the above observations, we need to have the fed fund target rate to remain stable for few months to pick bottom in S&P 500.

The fed did something different this time that they never did after 1991. They cut 125 basis points in a span of 10 days, out of which 75 basis points came in an emergency cut. As usual, the feds might be late and hence they had to compensate with a deeper cut.

My key take away from this chart is that as long as fed is cutting fed funds target rate, S&P 500 is generally in the downward direction. What do you think?

-Nidhi

Related links: Effect of Unemployment Report on S&P 500