Now doesn't that feel much better. The air is better down here, 25 bps lower than yesterday.
The news from the Fed is that housing could put a drag on economic output so they decided to lower rates 25 bps. These are bright people. Well, we knew they would lower by 25 bps but now they have to "justify" their position on the matter. Wednesday's GDP did not really look like a number that would "justify" a rate reduction so the disconnect continues.
Let's start with the GDP. The advance GDP is the first of three "estimates" on the production of the economy for the quarter. The Commerce Department surprised us when they said that GDP had risen a whopping 3.9% but then we looked a little deeper.
As we normally mention on the day the GDP is released, there is a little thing called the GDP price deflator. This is the number used to bring GDP to us without inflation. We try to describe this by saying the economy is made up of one item and it cost $100 last quarter and this quarter it costs $110 which would be 10% (for the quarter and GDP is always reported as an annual rate so this number is only for an example).
In our example, if we said that inflation was 10%, then GDP would be unchanged for the quarter but if we said there was no inflation, then GDP would be up 10% for the quarter. This is how you can report a bigger number, by indicating lower inflation. The price deflator for the first go around on GDP happens to be the lowest number since 1998 at 0.745%. This means that total GDP was about 3.9% plus about 0.8% from the price deflator for a total gross number of 4.7%.
We now go back to the Fed's rate reduction. By looking at their statement which says that they will be vigilant on inflation, we now must look at the price deflator for the past few quarters. This past quarter just reported was 0.745%, the prior quarter was 2.633%, and the quarter before that was 4.228%. That progression looks like a significant falloff.
That brings us to the Fed's fears. The Chairman didn't get his nickname without any reason. He's called Helicopter Ben because he actually said the Fed could drop money from helicopters to prevent deflation from occurring. Well, from the looks of the last few quarters, deflation is just around the corner. We know that the Fed is very keen on deflation and do Not want to deal with the results of it.
That then brings us to the rate cut. We are almost surprised, now that the GDP deflator is out, that the Fed didn't feel like it should lower rates by 50 bps. We have said recently that the market, the T-bill market that is, allows a 75 bps reduction and they only took 25 bps this time. Not only that, they made sure they included a statement about inflation in their release.