No. of Recommendations: 17
If fed funds drops by 2% tomorrow, there is no reason to believe that would increase inflation or stimulate the economy.That's the usual outcome, generally after a lag of about 18 months, in the same way that a 2% increase usually dampens economic activity. It doesn't always work precisely or indeed reliably, but it wouldn't be correct to say there is no reason to believe it.
As an aside, a 2% cut in the policy rate also usually causes the US dollar to drop in value, other things being equal. It's quite remarkable how weak the dollar has been lately given the large interest rate gap between dollars and other currencies, particularly euros, which yield far less. Usually with a gap this large the dollar would be rising strongly. This has led some commentators to speculate that a big interest cut would knock out the last strut holding the dollar up even as far as it has this year, and cause a real drop.
Here is a graph showing the correlation between the interest rate gap and the euro/dollar exchange rate in the few years up to January this year.
https://images.contentstack.io/v3/assets/blt40263f...If that deep link doesn't work, it's the second graph here
https://www.tastylive.com/news-insights/eur-usd-ec...As of today, the two year bund/bill gap is a full 2.0%. From that graph you'd "expect" FX at about $1.06 to the euro, but it's at $1.17, meaning the dollar has slid this year a bit more than 10% more than what you'd expect.
Another view of the same thing: if people aren't choosing where to put their cash based on the highest returns as they usually do, they might be choosing where to put it for other reasons. For anyone wanting to reduce exposure to the dollar, the most obvious next candidate is the euro. The biggest effect so far seems to be a moderate slow drifting of a lot of folks into euros and euro-area assets, which is driving up the euro, mainly against the US dollar but also in general. This is not good for the Euro zone economy or the profits of its companies, who are in any case seeing weakness and other headwinds like tariffs and the costs of war, so plowing into euro zone stocks thinking that they're a haven from all this geo-macro chaos might not work out fabulously. Plowing into euro cash has worked beautifully, however.
Jim
