On Tuesday the FOMC took a bold step and dropped the Fed funds target rate by 50 basis points, from 5.25% to 4.75%. This move sparked a 3.5% two-day rally in the S&P 500 and temporarily takes pressure off of some of the bad economic news. The question is how much of an impact this cut in the short rate will have on long rates, such as mortgages and corporate borrowings?

One thing we do know is that, as expected, the rate cut hurt the dollar, driving it to parity with the Canadian dollar (a situation we have not seen since 1976), and an all-time low against the Euro, breaking the $1.40/Euro level. Oil, which is demoninated in US dollars in global exchanges, has reached $83 per barrel. Inflation remains the other big variable and it is far too early to measure this cut’s effect.

A few things you want to keep your eye on is the impact this has on certain long rates, especially mortgages. The prime bank rate has dropped the corresponding 0.5%, but all other long rates, including 30-year and 15-year fixed mortgages, jumbos, and 5-year ARMs have all steadily risen this week. Yields on the 10-Year Treasury have risen more than 25 basis points this week. All of this indicates the Fed’s move has not quite worked out the way the FOMC must have envisioned. If the short rate cut does work its way into the rest of the credit market there would be some justification to the cut. Otherwise, the Fed may have just taken a wreckless move to temporarily satisfy markets at the long-term expense of our economy.

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