GM/Ford Downgrade, Fed, Rates

GM/Ford Downgrade, Fed, Rates

May 6, 2005

A very astute journalist from a European paper emailed me this morning asking if my piece last night on the GM/Ford downgrade being good for the markets meant that we could have a pause in interest rate increases and asked me to elaborate. The following is a brief version of my reply, FYI:

Yes, that is exactly what I mean. Also, the Fed will react to any upward pressure on interest rates by adding reserves when necessary. Together with today’s huge 274K job number and large upward revisions for both February and March imply the economy, and the stock market, will do better this year that economists expect.

The reason is that both bank and non-bank lenders (hedge funds and mutual funds) have been aggressively lending to private business borrowers since the mortgage refinancing boom ended last June. Hedge funds and mutual funds are buying the loans in order to offer more yield to yield-starved investors who often mistake them as safe money-market funds.

These business borrowers had been systematically starved of credit for 4 years–loans declined from $1.1 trillion in December, 2000 to $870 billion last May. In the past 12 months they are up more than $70B. This turnaround is fueling the expansion of small companies.

When economists look at the economy, they tend to focus too much on large public companies, because the data is available and their stories are so visible. But small private companies make up more than 50% of GDP and three quarters of jobs in the US.

We should not measure monetary policy by looking at the Fed funds rate alone. Credit availability to small companies is much more important. And by that yardstick, monetary policy is extraordinarily loose today. That implies more growth, more jobs, and better profit growth (especially among small cap companies) that Wall Street expects. And a much better stock market.

I am long small-cap stocks today.


John Rutledge

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