Fed delivers 3/4 point cut


The Federal Reserve slashed US interest rates on Tuesday, boosting Wall Street, which was already higher on stronger-than-expected investment bank earnings.

Tuesday's three-quarters of a percentage point rate cut was less than the full percentage point many in the market had expected, but the Fed left the door open to an additional reduction. However, it noted its future action would take inflation concerns into consideration.

“A lot of people were hoping for a full percentage point, so a lot of people are probably disappointed,” said Robert MacIntosh, chief economist at Eaton Vance Management, in Boston. “I don't think they should be. Inflation is an issue.”

Global stock markets were up early in the day in anticipation of the Fed's move and on stronger-than-expected earnings news from Goldman Sachs Group Inc and Lehman Brothers Holdings Inc. By the end of US trading, the Dow Jones industrial average jumped 420 points, or 3.5%, while the Nasdaq and S&P 500 indices rose more than 4%.

The dollar soared to its largest single-day gain against the yen in nine years and rallied against the euro as traders responded to the less-than-expected rate cut. But US Treasuries fell as investors poured into stocks.

The Fed's action, taken on an 8-2 vote of its policy committee, was part of an intense effort by the central bank to avert a deep recession and financial market meltdown. The move took benchmark overnight rates down to 2.25%, the lowest since February 2005.

“The Fed's action is yet another forceful move in its attempts to alleviate the liquidity crunch and to shore up a rapidly weakening economy,” said Arun Raha, a senior economist with Swiss Re, in New York.

“It clearly does not believe that the action it took last week to expand its securities lending program, or its emergency measures over the weekend to increase market liquidity, are enough. The economy is in, or close to, a recession, but increasing oil prices have kept inflationary pressures from abating, complicating the Fed's task.”

The central bank has now cut rates by an aggressive 3 percentage points since mid-September, including 2 points since the start of the year. In addition, it has said in recent days it would provide around $400 billion worth of liquidity to thaw frozen credit markets.

“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 said.

“There's been tremendous panic, people throwing the baby out with the bath water, preparing for a Category 5 hurricane, and that presents a buying opportunity,” said Chip Hanlon, president of Delta Global Advisors Inc in Huntington Beach, California.

Goldman Sachs, which has largely avoided the mortgage-related losses that have plagued much of Wall Street, said first-quarter earnings fell by half as it recorded steep losses on corporate loans and other assets. Yet the results at the largest US investment bank exceeded expectations.

Lehman Brothers, whose shares have been pummeled in recent days on concern it is the most vulnerable to troubled mortgages and leveraged loans next to Bear Stearns, suffered a sharp fall in bond trading revenue but benefited from rising merger advisory revenue.

In a statement outlining its rate move, the Fed said downside risks to economic growth remained even in the wake of the rate cut, suggesting an openness to lowering borrowing costs further if needed.

However, in the first double-dissent since September 2002, two officials - Philadelphia Federal Reserve Bank President Charles Plosser and Dallas Fed chief Richard Fisher - voted against the decision. They preferred less-aggressive action out of a concern sharp rate cuts could further fuel inflation.

Still, the Fed said it expected inflation to ease, partly because unemployment looked set to rise.

“The Fed has shown that they are focused on getting the economy back on its feet first and foremost, and they will worry about inflation later,” said K. Daniel Libby, senior portfolio manager at Sands Brothers Select Access Fund in Greenwich, Connecticut.

The rate action came two days after the central bank announced up to $30 billion in financing to facilitate the sale of cash-strapped investment bank Bear Stearns, an unusual intervention bank officials said was necessary to prevent cascading defaults in the financial system.

Its backing for JPMorgan Chase and Co’s agreement to buy Bears Stearns was one of a number of emergency steps the Fed announced on Sunday.

It also said it would extend loans to a wider array of Wall Street firms, not just commercial banks, for the first time since the Great Depression.

In addition, the Fed lowered the interest rate on “discount window” lending by a quarter-point on Sunday. On Tuesday, in concert with its decision to cut its target for overnight interbank lending by three-quarters of a point, it lowered the discount rate again by a matching amount, to 2.5%.

“The Fed is not only providing low-cost oxygen to the markets at a critical point in the business and credit cycle, it has also increased the flow of this oxygen quite significantly,” said Brian Bethune, an economist for Global Insight in Lexington, Massachusetts. (Reuters)

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