The "wall street journal" perspective in lay mans terms..............
WASHINGTON -- With a deepening credit crunch threatening to drag the
stalled
U.S. economy into recession, the Federal Reserve cut interest rates for
the
third time since August, and left the door open to further cuts.
But yesterday's moves, at the low end of Wall Street's hopes,
disappointed
investors, who had looked to the Fed to do more to thaw frozen credit
markets.
The Dow Jones Industrial Average fell sharply, undoing about a third of
the
run-up in stocks triggered in late November when top Fed officials first
publicly signaled that another rate cut was likely. The blue-chip
average ended
the day at 13432.77, down 294.26 points, or 2.1%.
The Fed lowered its target for the federal-funds rate, charged on
overnight
loans between banks, by a quarter percentage point to 4.25%. It also cut
the
discount rate, at which it lends directly to banks, by the same amount,
to
4.75%.
Fed officials, however, continue to consider ways of using various
tools -- including the discount rate -- to combat banks' unwillingness to lend
even to
each other, which they view as a threat to economic growth. The central
bank
could take action within days.
A variety of steps, widely discussed in the markets, are likely to be
on the
table, including another cut in the discount rate, longer-term loans to
money-market dealers, easier collateral rules for loans from the Fed,
and other
steps last taken in 1999 to alleviate funding pressures ahead of the
year 2000,
when many feared a "Y2K" computer bug would disrupt markets and create
economic
havoc.
Changes in the discount rate can be made by the Fed board in
Washington
without the approval of the entire 17-member policy-making Federal Open
Market
Committee, which sets the federal-funds rate target.
Some on Wall Street yesterday criticized the Fed's actions so far as
inadequate. "From talking to clients and traders, there is in their view
no
question the Fed has fallen way behind the curve," said David Greenlaw,
economist at Morgan Stanley. "There's a growing sense the Fed doesn't
get it."
Markets believe a weakening economy will force the Fed to cut rates
even more
than they expected before yesterday, Mr. Greenlaw said. Futures markets
anticipate another cut in January and a federal-funds rate of 3.25% by
next
fall.
In its statement yesterday, the Fed said that its quarter-point rate
cut,
which pushed the federal-funds rate a full percentage point below where
it
stood in early August, "should help promote moderate growth over time."
In October, the central bank said the risks of weaker growth and of
higher
inflation were roughly balanced, signaling it didn't expect to cut rates
again.
Yesterday, the Fed declined to give an explicit indication of its next
move. It
said it will assess financial and other developments and "act as
needed." The Fed's language left its options open for its next meeting in late
January.
The FOMC's 10 voting members approved the rate cut 9-1. Federal
Reserve Bank
of Boston President Eric Rosengren dissented in favor of a sharper,
half-point
cut. One FOMC member also dissented in October, but in favor of no rate
cut.
The shift in the dissents, from wanting less rate cutting to wanting
more,
shows the turn toward pessimism at the Fed.
"Economic growth is slowing, reflecting the intensification of the
housing
correction and some softening in business and consumer spending," the
Fed said yesterday. "Moreover, strains in financial markets have increased in
recent
weeks."
Unlike the previous two rate cuts, yesterday's wasn't portrayed as
"insurance" against improbable but potentially damaging economic
scenarios.
That suggests Fed officials view the economy as weaker than they
expected as
recently as late October.
Corporate executives are also signaling a more downbeat outlook. "I'm
not
going to put a happy face on this. Consumers are going to be a challenge
in
2008," General Electric Co. Chief Executive Jeffrey Immelt told
investors yesterday. But global growth is "as strong as ever," he added.
When Fed policy makers met in late October, financial markets were in
better
shape than they had been in August, and the economy had just posted a
strong
third-quarter performance. They chose to cut rates by a quarter point
and
concluded that would likely be enough.
But in subsequent weeks, markets reversed course as big losses tied to
soured
mortgage-related investments cut into the capital of major banks and
other
financial institutions, limiting their ability to lend. Fed Chairman Ben
Bernanke and Vice Chairman Donald Kohn signaled their increased concern
in speeches in late November, foreshadowing yesterday's rate cut.
Even so, investors, who have persistently had a gloomier outlook than
the
Fed, were disappointed the Fed didn't cut rates more or signal greater
willingness to do so. "Well, the boys blew it again. You wonder which
economy
they are looking at and what it is they are thinking about," said Alfred
Kugel,
Chicago-based chief investment strategist for investment-management firm
Atlantic Trust of Atlanta.
Bond prices shot up yesterday and yields, which move in the opposite
direction, fell sharply. The 10-year Treasury note's yield dropped to
3.97%
from 4.1% just before the announcement, while the two-year note's yield,
which is especially sensitive to expectations of Fed action, fell to 2.92%
from
3.13%. Yields on corporate bonds rose relative to Treasurys.
Major banks, meanwhile, lowered their prime lending rates, the
benchmark for
many consumer and business loan rates, to 7.25% from 7.5%.
The Fed has found it especially difficult to discern the economy's
path and
thus the right level for rates because the main threat facing the
economy is
the reluctance of banks and investors to lend to home buyers, businesses
and
consumers. That's harder to measure than the things that usually drive
the
business cycle -- such as profits, inventories, employment and the Fed's
own
interest-rate actions.
Brian Sack, an economist at Macroeconomic Advisers LLC, said that in
2001 the
major shock to the economy was the stock market. "We have a better shot
at
trying to calibrate those wealth effects, whereas the credit turmoil has
many
dimensions to it. Frankly it's hard to assess how much economic
restraint you
get from those various dimensions."
In the past month, data on the so-called real economy have been soft
but not
dramatically so. Macroeconomic Advisers said yesterday it now expects
economy to shrink marginally during the current quarter, then grow at a
1.8%
annual rate in the first quarter of 2008.
On the other hand, credit markets have tightened sharply. Since Oct.
31, the
yields on securities backed by auto loans have jumped to 6.3% from 5.4%,
while
yields on securities backed by home-equity loans have jumped to 7.7%
from 6.6%,
according to J.P. Morgan Chase & Co. Rates on "jumbo" mortgages -- those
larger
than $417,000 -- are around 6.9%, up from 6.6%. The London interbank
offered
rate, the rate banks charge each other for three-month loans in the
offshore market -- is a full percentage point above the expected federal-funds
rate; it
is typically less than a tenth of a point higher.
There isn't yet evidence these higher rates have significantly bit
into
consumer spending, outside of housing, and the rates could drop after
year-end
funding pressures ease. But investors generally don't expect that to
happen.
A survey by Macroeconomic Advisers of 55 clients, mostly hedge funds
and
other sophisticated investors, found most expect little retracement of
the wide
spreads between yields on risky debt and Treasury yields by next year,
and most expect banks to curtail lending. "The possibility of a widespread
pullback in
credit availability is a significant risk to the outlook," the firm
said.