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Fed cuts rates to fight recession, deflation

Trader Jeffrey Vazquez watches monitors trading floor New York Stock Exchange after interest rate decisiFederal Reserve Tuesday. The Federal Reserve

Trader Jeffrey Vazquez watches monitors on the trading floor of the New York Stock Exchange after the interest rate decision of the Federal Reserve, on Tuesday. The Federal Reserve slashed the federal funds rate to virtually zero.

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Updated: May 3, 2013 12:14PM

How low can interest rates go? We're about to find out. The Federal Reserve just cut its short term interest rate target from 1 percent down to a range of zero to .25 percent.

Yes, that's correct. Short-term rates will now be pushed to their lowest level in history, in another attempt to jump-start the economy.

The Fed signaled that it will also attempt to cut longer-term interest rates, typically set by the market. They'll be buying 10-year government bonds -- currently yielding 2.25 percent -- a move that will push bond prices up and yields down. Late Tuesday, many banks cut the prime rate from 4 percent to 3.25 percent.

All of that is good news for those with adjustable rate mortgages or home-equity loans that are pegged to short-term government rates or the prime rate. But it doesn't guarantee that credit card rates will drop.

And, more important, it doesn't guarantee that credit will be available if lenders remain afraid to take risks in a slowing economy.

The banks are already flush with cash, made available by the Fed and the Treasury's Troubled Asset Relief Program. But that cash is backing up in the bank vaults. There's no rush for banks to make loans -- especially at lower interest rates.

On the other side of the ledger, there's no sign that consumers will be demanding loans to expand their small businesses or add to their credit card debt.

Sensible consumers -- and those finally coming to their senses -- are cutting back on spending and borrowing, whether on autos or homes or retail spending.

There was one place where interest rates moved higher Tuesday. The Blagojevich scandal drove interest rates on the State of Illinois' short-term bonds higher, costing Illinois taxpayers an extra $20 million, according to state Treasurer Alexi Giannoulias. The State of Illinois paid more to sell its short term bonds because Moody's Investors Service cut Illinois bond rating to MIG-2, making the bonds less attractive and requiring the state to pay higher rates to investors to raise cash to pay its bills.

The economy is not only in the midst of a recession, it's also facing deflation. Falling prices are everywhere -- home prices, energy prices, auto prices and department store sale prices. On Tuesday, the Labor Department reported that the Consumer Price Index declined 1.7 percent in November.

The Fed's rate cut announcement had one positive impact. The Dow Jones industrial average jumped 360 points, or 4.2 percent. These low interest rates make stocks, especially those that pay dividends, look like bargains compared to the low yields on bank CDs and money market accounts.

Gold prices also soared $20 to $860 an ounce. Investors clearly looked beyond the current deflationary situation to a potential glut of dollars being created by the Fed as they push liquidity through the markets.

But worries about inflation are far down the road. Right now the Fed is signaling that it will do everything possible to fight deflation and a growing recession.

In fact, it has now done just about all it can -- at least in its traditional role.

And that's the Savage Truth.

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