The financial markets have cast their vote for a 50-basis-point interest rate cut. In the days leading up to the Federal Reserve's two-day meeting that began Tuesday, Fed officials were trying to talk expectations down. They've been telling anyone who will listen that a 25-basis-point cut is still a real possibility. Whatever the Federal Open Market Committee does Wednesday, however, all of us -- Fed policymakers, CEOs, retirees, investors and consumers -- are about to begin a journey into uncharted economic and monetary territory. Let's hope it doesn't get too exciting. If the Fed cuts the federal funds rate -- now at 1.25% -- to 1% or 0.75% with a cut of 25 or 50 basis points, the real rate would be deeply negative. With core inflation running at 1.6% annually, the real federal funds rate could be a negative 0.85. Money market accounts, which currently pay just 1.35% on average (a negative return when inflation is factored in), are likely to drop even more into the red. The three-month Treasury bill is already paying just 0.8% in anticipation of the Fed's move. The Fed's stated goal is to provide enough liquidity at a low-enough price to get the economy rolling again at something above the 1.9% growth in U.S. gross domestic product recorded for the first quarter of 2003. But no one knows what kind of unintended consequences cutting interest rates to 1% or less will have as the rate cuts ripple through the global economic and monetary systems. Let's look at five areas where the unintended effects are largely unknown but could be huge.
Will Money Market Funds 'Break the Buck'?
I doubt it. Investors have come to believe that no matter how low the yields in a money market mutual fund go, the safety of their principal is guaranteed. Any fund that allows the price of shares purchased for a dollar to fall below a dollar risks extinction.