Fed Cuts Rate Half Point, and Stock Markets Soar

Fed Cuts Rate Half Point, and Stock Markets Soar


Hiroko Masuike for The New York Times
Traders on the floor of the New York Stock Exchange Tuesday.

By EDMUND L. ANDREWS

Published: September 19, 2007

WASHINGTON, Sept. 18 — The Federal
Reserve rolled out its most powerful interest rate weapon on Tuesday in
a bid to stop the turmoil in housing and financial markets from
bringing down the overall economy. Skip to next paragraph


Related


Federal
Reserve Statement
Times Topics: Mortgages
and the Markets
Ben
S. Bernanke


Multimedia

Back Story With The Times's Gretchen Morgenson (mp3)


The New York Times


But even as stock markets
soared in a thunderous rally, the Fed carefully stopped short of
implying any commitment to reduce rates even more in the months ahead.
Indeed, policy makers cautioned that they still have lingering worries
about inflation — a concern that would weigh against stimulating the
economy further with cheaper money.In reducing its benchmark
interest rate by an unusually large one-half percentage point, to 4.75
percent from 5.25 percent, the central bank made it clear that policy
makers viewed the turbulence and disruptions of the past couple of
months as too dangerous to ignore. The reaction in stock
markets was ecstatic: the Dow Jones industrial average jumped 200
points almost instantly and ended the day up 335 points, or 2.51
percent, at 13,739.39. The move was the Fed’s first rate
reduction of any kind in four years, the steepest in nearly five years
and its most abrupt reversal of course since January 2001, when policy
makers sharply cut rates at an unscheduled emergency meeting just
before the last recession. “Shock therapy,” summed up Ethan Harris, chief United States economist at Lehman Brothers.For
consumers, the Fed’s move could mean lower borrowing costs for
mortgages and automobile loans. But the impact may be muted, because
investors remain deeply anxious about the credit quality of mortgages
and other long-term loans. The main problem in the last month has not
been high rates so much as the availability of capital to complete
deals.Analysts described the Fed’s action as a bold attempt to
restore confidence with a quieter caveat that investors and consumers
should not assume the certainty of more painkillers later this year.“The
important policy debate now centers on the future interest rate path,
but Fed officials left that more ambiguous,” said Richard Berner, chief
United States economist at Morgan Stanley.Indeed,
while many on Wall Street have been clamoring for an aggressive rate
cut, some economists had warned against it, saying that it might send
the wrong signal by bailing out those who contributed to the housing
bubble and encourage future market excesses.In both the bold
stroke and the fine print, the Fed’s move offered a revealing hint
about Ben. S. Bernanke, the former professor from Princeton who took
over as Fed chairman last year. Mr. Bernanke, a champion of
steady rules to guide monetary policy, has long been seen as more
skeptical about reacting to financial turbulence than his predecessor, Alan Greenspan. Mr.
Bernanke, for example, made it clear that he did not want to rescue
investors or real estate speculators who made bad decisions. But in
shielding the economy from a downturn, the Fed will inevitably be
helping some of the very people Mr. Bernanke did not want to help.
What seems to have driven Mr. Bernanke to act more boldly, analysts
said, was the jolt from the Labor Department’s unexpectedly poor
employment report for August, which showed that the nation had lost
jobs for the first time in four years.Still, Mr. Bernanke’s move
was nothing if not a Greenspanian display of “discretionary” policy in
response to trouble but before the signs of an economic downturn were
unambigious. And in doing so, he obtained unanimous agreement from
other board members, even though some Fed officials have been dubious
about the need for a rescue.The Fed’s course change has been
under way since early August, when fears about huge losses on subprime
mortgage loans and continued downturn in housing caused a much broader
panic in credit markets. The resulting credit crunch has now
affected all but the safest home mortgages, and also greatly reduced
the ability of private equity funds and hedge funds to borrow money at
low rates. Many banks, which had been planning to resell their loans
into the giant market for tradable commercial debt securities, are now
being forced to absorb loans that the securities markets will no longer
take. In the rate cut and an accompanying statement, the
central bank acknowledged that the risks of a recession were too big to
ignore.“The tightening of credit conditions has the potential to
intensify the housing correction and restrain economic growth more
generally,” the Fed’s policy-making committee said in its statement.
“Today’s action is intended to forestall some of the adverse effects on
the broader economy that might otherwise arise from the disruptions in
financial markets.”

Leaving the door open for the possibility of additional rate cuts,
the central bank said it would “continue to assess” the economic
outlook and “act as needed to foster price stability and sustainable
economic growth.” Skip to next paragraph

Related
Federal
Reserve Statement
Times Topics: Mortgages
and the Markets
Ben
S. Bernanke


Multimedia

Back Story With The Times's Gretchen Morgenson (mp3)


But while Fed policy makers
abandoned previous statements that the risk of inflation was their
“predominant concern,” they did not say that the risk of a downturn had
replaced inflation as their main worry. Rather, they spoke of
“uncertainty” and left it at that.“The Fed kept its cards much
closer to its vest than anyone would have guessed,” said David
Rosenberg, chief North American economist for Merrill Lynch. “It’s not at all clear they think they have more to do.”
Trading among investors indicated that Wall Street expects the central
bank to keep cutting rates. Many analysts contend that it needs to cut
twice as deeply as it has so far by early next year. And in a
sign that the politics of rate-cutting could become more bruising, at
least one prominent Democrat quickly criticized the Fed’s cautionary
warning about inflation at a time of slowing growth. Representative
Barney Frank, Democrat of Massachusetts and chairman of the House
Financial Services Committee, said he was “surprised” by the Fed’s
statement. “I hope, in this instance, that markets and consumers
will pay more attention to what the F.O.M.C. did than to what it said,”
Mr. Frank added, referring to the Federal Open Market Committee, which
sets interest rates.In a separate move to bolster the banking
system, the Fed also said that it had cut its discount lending rate,
which applies to short-term emergency loans to banks, by a
half-percent, to 5.25 percent.As in 2001, the Fed’s move came
after a panic in financial markets and the collapse of a speculative
bubble. Today, the panic is in credit markets spooked by dubious
mortgages on inflated housing prices. Back then, it was the stock
market that crashed, initially because the air went out of inflated
dot-com stocks.But the debate within the Fed was all about risk
probabilities: what were the odds that the twin meltdowns in housing
and mortgage markets would tip the overall economy into a recession?
If policymakers cut rates too cautiously, they risk a recession; if
they cut them too much or too early, they risk stoking inflation.Ever
since the jobs data was released earlier this month, it seemed clear
that Fed policy makers were no longer debating whether to reduce rates
but how much to lower them. A smaller rate reduction posed a risk of
moving too slowly if the economy was indeed in danger of stalling. But
a bigger rate reduction could have been taken as a sign of Fed panic,
and it added to the risk of stoking inflationary pressures that the
central bank had just begun to tamp down.Just a few hours before
the central bank announced its decision, new statistics indicated that
the pace of home foreclosures is accelerating. RealtyTrac of
Irvine, Calif., reported that the number of foreclosure filings — from
default notices and auction sale notices to bank repossessions — was 36
percent higher in August than in July and 115 percent higher than one
year ago. But except for the housing downturn, which Fed
officials admit is much more severe than they had expected, the
evidence of a recession in the real economy is indecisive. Global
economic growth is much stronger than in 2001, and American exports
have climbed about 14 percent over the past year. Instead of
the United States being the world’s engine of growth, the global
economy could now become the engine of American growth.Many Wall
Street economists place the odds of a recession at about one-in-three
or somewhat higher. Mr. Greenspan puts the odds at somewhat more than
the one-in-three that he estimated earlier this year. On Aug.
17, the Federal Reserve moved to ease the liquidity crisis by
encouraging banks to borrow money through its “discount window,” a
program originally created as an emergency source of overnight funding
for banks in a cash squeeze. But by most accounts, the turmoil
in credit markets has abated very little. The market for subprime
mortgages has all but disappeared and demand for all forms of
asset-backed commercial paper, which are securities backed by
mortgages, credit card debt and company receivables, remains very weak.

Righting the Economic Ship?

Mike Mish Shedlock Sep 18, 2007 3:56 pm






Micromanagement by the Fed in response to every economic ill just
creates bigger and bigger bubbles until it all blows sky high.


Well,
the Fed made its choice and anyone who thought the Fed cared about the
U.S. dollar found out otherwise. The U.S. dollar fell to a record low
against the Euro, gold is breaking out to a 27-year high and oil is at
another new high as well, up 33% or so on the year.

Click here to read the full FOMC statement, the beginning of which is shown below.
<blockquote dir="ltr" style="margin-right: 0px;">
The Federal Open Market Committee decided today to lower its
target for the federal funds rate 50 basis points to 4-3/4 percent.

Economic
growth was moderate during the first half of the year, but the
tightening of credit conditions has the potential to intensify the
housing correction and to restrain economic growth more generally.
Today’s action is intended to help forestall some of the adverse
effects on the broader economy that might otherwise arise from the
disruptions in financial markets and to promote moderate growth over
time.

Readings on core inflation have improved modestly this
year. However, the Committee judges that some inflation risks remain,
and it will continue to monitor inflation developments carefully.
</blockquote>

Obviously the Fed is a lot more worried than it is letting
on. This is yet another panic move by Bernanke. The first panic move
was a cut in the discount rate 50 basis points (See Futures Fireworks and Moral Hazards).
And more panic moves can be expected when the economy does not respond
to these cuts. The stock market may be excited today but the bond
market was unimpressed to say the least.

Curve Watchers Anonymous is back watching the Yield Curve.


Click here to enlarge.

Once again the pivot point is the 5-year treasury and there is a selloff on the long end and a rally on the short end.

I was listening to Bloomberg and one of the homebuilders, Toll Brothers
(TOL), said "Our boy has righted the ship". The above yield curve shows
how little this cut is going to matter to anyone in a mortgage tied to
the 10 year treasury. There is a possibility of a revolt on the long
end, and/or mortgage rates will continue to disconnect from treasuries
as they have done now for quite some time.

NAHB Wells Fargo Housing Market Index

Click here to enlarge.

The traffic of perspective buyers sits at 16 and the overall index at 20. Anything under 50 shows contraction.

Bank of America (BAC) and Wells Fargo
(WFC) both lowered their prime rate to 7.75% from 8.25%. In other
words, they have given up 100% of benefit of the drop in rates by
passing it all on. But how many qualify for the prime rate, and more to
the point who really wants to borrow in a clearly slowing economy
unless they have to?

It's going to take a lot more than 50
basis points to "right the ship". And the ship I am talking about is
the economy, not just homebuilders. Besides, the medicine is wrong. It
was panic moves by Greenspan (with Bernanke voting with Greenspan every
time), that created the credit bubble. Panic moves to lower interest
rates can hardly be the cure. Bernanke has proven the inability to
distinguish problem from solution. I talked about this in Bernanke Proves he is a Complete Fool.

Micromanagement
by the Fed in response to every economic ill just creates bigger and
bigger bubbles until it all blows sky high. It's high time to abolish
the Fed and give the free market a chance.