Tuesday, January 22, 2008

Fed Cuts Interest Rate 75 Basis Points

The Federal Reserve, after reviewing the significant global stock market declines on Monday and again on Tuesday, which were at least partially caused by increased fears of a US recession, lowered the federal funds rate by 75 basis points, or three-quarters of a percentage point this morning and indicated further rate cuts were likely. This surprise reduction in the federal funds rate from 4.25% down to 3.5% percent is the most significant one-day rate move by the central bank since it cut the discount rate by a full percentage point in December 1991, a period when the country was struggling to get out of a recession.

In addition to cutting the federal funds rate, the Fed said it was reducing the discount rate, the interest it charges to make direct loans to banks, by a similar three-quarters of a percentage point, pushing this rate down to 4%. Commercial banks responded to the Fed's action on the funds rate by announcing similar cuts of three-quarters of a percent on its prime lending rate, the benchmark for millions of business and consumer loans. The action will mean the prime lending rate will drop from 7.25% down to 6.50%.

The Fed's interest rate moves came after significant declines in Asian and European markets on Monday, while the US markets were closed in observance of the Martin Luther King Holiday, and again overnight and into this morning as global markets continued their sell off. By midday, the U.K.'s FTSE 100 was down 0.3 percent at 5,560.90, Germany's DAX was down 1.7 percent at 6,671.82, while France's CAC 40 dropped 1.3 percent to 4,681.07.

Japan's Nikkei 225 index tumbled 5.7 percent, its largest percentage drop in nearly 10 years, to 12,573.05, a day after falling 3.9 percent. Australia's benchmark index sank 7.1 percent, its steepest one-day slide in nearly 20 years. Hong Kong's Hang Seng index, which slumped 5.5 percent Monday, finished down 8.7 percent on Tuesday. In China, the Shanghai Composite index lost 7.2 percent to 4,559.75, its lowest close since August. Indian Finance Minister P. Chidambaram urged investors to remain calm after trading in Mumbai was halted for an hour when the stock market there fell 10 percent within minutes of opening. The Sensex rebounded some to close down 5 percent after plunging 7.4 percent Monday.

Early market reaction to the Fed's rate reduction was not positive, as the DJIA opened off 450 points. However, as the morning wore on, the losses subsided to a more palatable 150 points off of Friday's close. Whether this will be a complete capitulation and subsequent end of the bull market remains to be seen. Closing values of 1,252.12 in the S&P 500 and 11,331.62 in the DJIA would indicate a 20% decline for those two indices from their highs in October 2007. Even if a recession is avoided, I think global markets are making a huge statement regarding the theory of decoupling, that is, the belief global markets and economies could continue to thrive during a downturn in the US.

The positive news for the day is the European markets seemed to like the Federal Reserve's interest rate decision, because even though they were down at midday, they managed to end on the plus side, for the most part. European policymakers offered no hint on Tuesday they would rush to join the United States with a stimulus plan to inoculate their economies from the ravages of a global stock market rout. The economy is sound and fear and panic should not drive decision making, European Central Bank officials said after the U.S. Federal Reserve's surprise move to slash interest rates.

Jean-Claude Juncker, the senior finance minister for the euro zone economies, said he was keeping a close eye on developments but right now saw no danger of U.S. driven turmoil spilling over to cause a global recession. "When financial markets act irrationally, and are driven by herd behaviour, when stock markets demonstrate short-termism, there is no reason for finance ministers to do the same," Juncker told reporters on arriving for Tuesday's talks. Someone should show the above quote to the alarmist politicians in Congress and the White House before they overstimulate the economy, increase food stamp subsidies and who knows what else. Washington's overreaction and the election year grandstanding could further damage the economy or inflate a bubble in another sector by easing credit too much. Sometimes, less is better, especially when it comes to political demagoguery and bogus spending programs appealing to special interest groups.

John Kaighn

Jersey Benefits Advisors

Plug In Profit

John Kaighn's Web Business Review

John Kaighn's Guidance Website