Fed cuts rates in emergency move

But this won’t dispel bear’s shadow over loss-ridden markets

WITH the world staring down the throat of what billionaire investor George Soros called its worst financial crisis yet, and its biggest economy driven to possible recession by fallout from sub-prime mortgage losses, the United States Federal Reserve yesterday slashed interest rates by 75 basis points — the biggest cut in 23 years.

The central bank lowered the federal funds rate target to 3.5 per cent from 4.25 per cent, the policy-making Federal Open Market Committee (FOMC) announced, in its first such emergency move since Sept 2001.

Policymakers were not scheduled to meet to set rates until Jan 29-30. The FOMC said it took the action yesterday “in view of a weakening of the economic outlook and increasing downside risks to growth”.

It was a move some commentators said smacked of panic, but perhaps, panic that was called for.

“While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate,” the committee said.

The FOMC also lowered the discount rate by 0.75 percentage point to 4 per cent.

The emergency measure helped stem major losses in the Dow Jones Industrial Average (DJIA) after trading resumed following the long weekend.

US markets were closed on Monday to mark Dr Martin Luther King’s birthday. At press time yesterday, the DJIA was down 260.77 points, or 2.14 per cent, at 11,838.53, after the futures contract had indicated a decline of as much as 5.3 per cent earlier.

But despite yesterday’s rate cut — the largest single shift in interest rates since November 1994 — questions remain as to when the global crisis of confidence will end.

That’s a US$300-billion ($430-billion) question, according to the Organisation for Economic Cooperation and Development, which said there might be that much in losses sitting in the market for collateralised debt obligations, which include the infamous US sub-prime mortgages.

So far, the tally of losses from Wall Street is about US$100 billion — so, the end to the stock market woes may yet be several hundred billion dollars away.

And the potential for exposure to these bad investments to turn up in unexpected places now hangs like a Sword of Damocles over the world’s markets.

Until investors know where most or all of the remaining bad debt in the world resides — or until they have priced in the potential for this to turn up anywhere — the market’s crisis of confidence is likely to continue.

“Many investors appear to believe the write-downs are far from over,” said Lehman Bros’ chief regional equity strategist Paul Schulte.

Yesterday’s inter-meeting rate cut was the first since Sept 17, 2001, when the Fed lowered borrowing costs in the aftermath of the terrorist attacks — that was the third emergency reduction in a year which saw the last US recession.

Last Thursday, Fed chairman Ben Bernanke warned in testimony to Congress that the US economic outlook had worsened and “the downside risks to growth have become more pronounced”. Still, he said, the Fed wasn’t forecasting a recession this year.

US retail sales fell last month, unemployment rose and housing markets are mired in the worst slump in 16 years. Homebuilders in the US broke ground on the fewest homes since 1991, according to the Commerce Department. Building permits — a sign of future construction — declined by the most in 12 years, suggesting the housing slump will deepen.

US Treasury Secretary Henry Paulson called yesterday’s rate cut by the Fed “very constructive” and a “confidence builder”. He said it was a sign to the rest of the world that the US central bank is “nimble”. — Agencies

Source : Today – 23 Jan 2008

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