US Feds Slash Interest Rates

As reported in the Globe and Mail this afternoon, the U.S. Federal Reserve Board slashed interest rates by three-quarters of a percentage point Tuesday and left the door open to more cuts, moving aggressively to stem a financial market meltdown and avert an economic recession.
Under the watch of Chairman Ben Bernanke, the Federal Open Market Committee voted at its scheduled meeting to bring the benchmark U.S. federal funds lending rate down to 2.25 per cent. The Fed's decision was not unanimous, with two of 10 policy makers dissenting in favour of “less aggressive action.”

In the statement accompanying the decision, the Fed said that the outlook for economic activity has weakened further, consumer spending has slowed and labour markets have softened. “Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.”

The central bank also noted that although it expects inflation to moderate in the coming quarters, uncertainty over the outlook for inflation has increased.

“Today's policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity,” the Fed said. “However, downside risks to growth remain.”
Charmaine Buskas, a senior economic strategist with TD Securities, said the tone of the Fed's statement points to further rate cuts, with the central bank noting that it will “act in a timely manner as needed to promote sustainable economic growth” and price stability.
“Given that credit markets remain in a fundamental paralysis, and the economy continues to unwind, we are of the view that the Fed will remain in an easing cycle for the next few meetings,” Ms. Buskas said. “The key issue is to first unclog the credit markets and get the wheels turning again.”

Ian Shepherdson, the chief U.S. economist at High Frequency Economics, said that by April 30 Mr. Bernanke should be able to extract another 50-basis-point cut from his more reluctant colleagues. “This will all make no difference to the near-term data, but it is a necessary precondition for recovery, eventually.”

Tuesday's cut is the sixth time in as many months that the U.S. central bank has lowered the federal funds rate, which is now at its lowest level since December, 2004. The rate was 5.25 per cent in August, when the troubles with U.S. subprime loans first escalated and began spreading to capital markets and the wider economy.

Although Tuesday's 75-basis point reduction is large by historical standards, it is bound to disappoint some investors. The Fed also eased rates by 75 basis points at an inter-meeting move two months ago.

Fed-funds futures had priced in a full percentage-point cut after this weekend's stunning near-collapse of investment bank Bear Stearns Cos. Inc. sent shockwaves through markets.
Stock markets in both Canada and the U.S. pared gains immediately after the Fed announcement, although both recovered in the final hour of Tuesday's trading session.

Global credit jitters escalated this past weekend when JPMorgan Chase & Co. agreed to step in to buy Bear Stearns for just $2 (U.S.) a share after the Fed said it would backstop the deal. The central bank announced that it would provide funds to any other troubled investment dealers for the first time since the Great Depression, moving away from its traditional policy of only lending to large commercial banks.

Over the weekend, the Fed also made an emergency quarter-point cut to its discount rate to 3.25 per cent.

Mr. Bernanke has been pulling out all of the stops, taking new and extreme steps in his efforts to ease the credit crunch, set financial institutions on a more stable footing and calm financial and stock markets. Fears that the Bear Stearns situation could trigger similar meltdowns at other financial companies sent Canada's equity market into a tailspin on Monday.
Bank of Canada Governor Mark Carney has said that while he is monitoring the situation, Canada's monetary policy will be driven by domestic conditions, not by panic in global financial markets or external credit problems.

The central bank lowered Canada's rates by a half-point to 3.5 per cent on March 4, citing a weaker-than-expected U.S. economy. According to a spokesman, the last time in modern history that the Bank of Canada slashed rates by 75 basis points was on Oct. 23, 2001.

Warmly,
Mary Wozny