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08 June 2023

Fed set to cut rates again

By Agencies


The Federal Reserve is likely Tuesday to follow its emergency weekend move to ease credit gridlock with a large rate cut in a bid to stem a mushrooming financial crisis, analysts say.

The intensifying market turbulence has led economists to anticipate a hefty cut in the federal funds interest rate, possibly as much as a full per centage point, as the central bank steps up its battle against a global credit crunch.

Joseph LaVorgna, senior economist at Deutsche Bank, said he expects the federal funds rate to be slashed from 3.0 per cent to 2.0 per cent.

"A deeper and longer recession seems more likely now than a brief, mild one," he said, saying the rate may be slashed to as low as 1.0 per cent by the end of June.

Others say the Fed must act to avert a broader economic meltdown.

"We are in the midst of the most pervasive financial crisis in a generation, which has destroyed untold sums of wealth in housing and financial assets and has driven the US economy into recession," said Sherry Cooper, chief economist at BMO Capital Markets.

Cooper said Fed members "will continue to act aggressively until they see sustained stabilisation. Let's hope they are successful."

Most Asian stock markets -- with the exception of Japan -- continued to fall Tuesday in the face of concerns over the US economy.

Chinese Premier Wen Jiabao expressed concern over US economic weakness.

"I am paying great attention to the world economy. I am especially worried about the US economy," Wen said Tuesday at a press conference.

"What I'm worried about is that the US dollar continues to depreciate, when will we see it hit the bottom? What kind of monetary policy will the US take and what direction will its economy take?"

Yet analysts in the United States are debating how much the US central bank can do to alleviate the crisis, which was this week underlined by a spectacular meltdown at the Wall Street investment giant Bear Stearns.

Rushing to keep cash flowing in the financial system after the Bear Stearns episode, the Federal Reserve cut its discount rate and made a pledge of aid to the brokerage system Sunday.

A quarter-point cut to 3.25 per cent was made to the primary credit rate, which is the rate offered at the Fed's discount window for loans to institutions "in sound condition".

The Fed also said it would make liquidity available starting Monday to "primary dealers," which include brokerages that were not previously eligible for direct loans from the central bank. The Fed board also extended the maximum time of discount window loans to 90 days from 30 days.

"These actions demonstrate the extreme lengths, if there was ever any doubt, that the (Fed) Board of Governors are willing to go to" to keep markets functioning, said Bob Eisenbeis, economist at Cumberland Advisors.

The Fed has already slashed its federal funds rate by 225 basis points from 5.25 per cent last September, in an effort to ease housing and credit market stress.

But some analysts said it was not clear how much the Fed can do to prop up sagging confidence.

"The Fed has pulled nearly every non-conventional rabbit out of the hat to provide liquidity," said Merrill Lynch economist David Rosenberg.

"The next steps may be to try and prevent a contagion, or a domino impact, and the Fed has responded to this prospect by opening the discount window to the dealer community."

But Rosenberg added that the Fed, which has pumped an estimated $1 trillion into the banking system, has no magic bullet.

"What we are learning first-hand is that the Fed can't solve all of the world's problems," he said

"The Fed cannot recapitalise the banking sector, nor can it renew investor confidence in the quality of opaque financial sector balance sheets."

Economist Brian Wesbury at First Trust Portfolios calls the Fed's aggressive rate cuts "a mistake."

"Interest rate cuts since August have been counterproductive," he said. "They have created an incentive for businesses and consumers to postpone activity. Why do something today if rates will be lower next week or month?" (AFP)