Fed set to make fresh rate cut as credit crisis worsens

Published Sunday, March 16, 2008

By Agencies

With a global credit crisis mushrooming and financial market turmoil unabated, the Federal Reserve is expected to announce another hefty rate cut Tuesday to help confidence and liquidity.

Even after new efforts to pump liquidity into markets by the Fed, the possibility of the collapse of US investment giant Bear Stearns and a variety of financial firms and hedge funds have hurt confidence, forcing the Fed to act further on rates, say analysts.

The Federal Open Market Committee headed by chairman Ben Bernanke is expected to slash the federal funds rate, currently at 3.0 per cent, after a series of cuts since September. Many analysts expect a half-point reduction while others say the move may be bigger.

"The market expects the Fed to cut rates by 75 basis points to 2.25 per cent with 40 per cent odds of a 100 basis-point cut on Tuesday," said a report from Thomson IFR Markets. "We think a 50 basis point cut will be appropriate."

Some say the Fed wants to send a strong message that it will do what is necessary to ease a global liquidity crunch.

"With the housing market collapse spilling over to worsening credit conditions, and credit tightening threatening to further weaken the economy, we expect the Fed to ease 75 basis points at this week's meeting," says Peter Kretzmer, senior economist at Bank of America.

"We project a 1.5 per cent federal funds rate target by mid-year but note the unusual degree of fluidity surrounding policy at this juncture."

Sherry Cooper, chief economist at BMO Capital Markets, said she expects a cut of at least 75 basis points to 2.25 per cent.

"The US economy is in recession. The risks are on the downside, reflecting the loss of business and consumer confidence, the liquidity squeeze and counterparty risk," Cooper said.

"Expectations of near-term improvement have been dashed by the latest developments: the continued fall in the US dollar, oil prices rising to $110 a barrel, gold climbing to over $1,000 an ounce, the US housing market's continued collapse, and the further downdraft in consumer spending. Expect the Fed to cut interest rates rapidly, most likely 75 basis points (or more) at next week's meeting."

The Fed last week unveiled a targeted move to get liquidity to banks and brokerages holding mortgage securities they are unable to trade because of frozen market conditions.

A new auction system will allow many financial firms to swap the tainted mortgage debt for Treasury bonds in an effort to get credit flowing again.

But enthusiasm for the plan was short-lived as Bear Stearns, a Wall Street investment giant, was forced to seek a bailout from the Fed via JPMorgan Chase, because the new central bank facility would not be available until March 27.

"This is certainly not a contained development," said Cooper.

"Other firms will likely continue to suffer the results of the credit crunch and loss of investor confidence. Some have argued that the Fed is merely prolonging the pain by providing so much liquidity."

One bit of positive news came in inflation data, which showed consumer prices unchanged in February, possibly giving the Fed more room to cut rates to rekindle growth without fears of "stagflation."

"We believe the Fed will cut rates by 75 basis points next week in order to offset tightening financial market conditions," said Deutsche Bank economist Joseph LaVorgna.

"Eventually, inflation will moderate in response to the economy's weak performance."

Others argue the Fed may be powerless to stem the crisis and is rekindling inflation by cutting rates.

"One view is that aggressive Fed easing is rewarding risk takers, laying the groundwork for another asset bubble and a serious bout of inflation," said Ethan Harris, economist at Lehman Brothers.

But Harris added: "The Fed is in a no win situation: it cannot ease and tighten at the same time."

As a result, he said Bernanke and company have little choice but to try to avert an economic meltdown by slashing rates, and argues the Fed will go as low as 1.0 percent despite worries that such low rates several years ago fueled the real estate bubble.

"We now expect the Fed to cut by 75 basis points on March 18, 50 basis points in April, 50 basis points in June and by a final 25 basis points in early 2009, bringing the funds rate back down to 1.0 per cent," said Harris. "Who says history does not repeat itself?" (AFP)

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The page was last updated on: 14 January 2016 16:01