Federal Reserve cuts rates to 1.25% [Half Point Cut, Not The Quarter Point Expected]

CBS Marketwatch ^

[fm1]

WASHINGTON (CBS.MW) - The Federal Reserve cut interest rates Wednesday to try to get the economy humming again.

By cutting the federal funds target rate to 1.25 percent, the Fed hopes to boost consumer and investor confidence and pump more money into an anemic economy.

"Greater uncertainty, in part attributable to heightened geo-political risks, is inhibiting spending, production and employment the Fed said.

The vote for such action was unanimous.

The group said the risks in the economy are now balanced.

It was the first rate cut since December. The Federal Open Market Committee had cut rates 11 times in 2001, bringing the fed funds rate from 6.50 percent to 1.75 percent.

The move was expected on Wall Street. Forecasters were nearly unanimous in their belief that the FOMC would ease monetary policy Wednesday.

Financial markets had fully priced in a 25 basis point cut and were hedging their bets that the cut would be an aggressive 50 basis point cut.

The federal funds rate is the interest rate banks charge each other for overnight loans. The Fed targets this rate by buying or selling Treasurys in the open market. To goose the economy, the Fed adds money to the system. To contract the economy, the Fed takes money out. Read more about monetary policy.

The economy officially entered a recession in March 2001 after months of slipping industrial production and falling stock prices.

The FOMC had held its fire since last December. It is likely that the private-sector National Bureau of Economic Research will eventually determine that the recession ended in December or January -- if the economy doesn't dip back into a recession now.

The NBER said Tuesday that the recession "may have come to an end," but would wait to make its decision.

The FOMC has been warning since August that the main risk to the economy is a relapse, signaling its intention to cut rates again if the economy appears to be worsening. Even before the FOMC changed its official risk assessment, the committee had said the most likely outcome was a tepid recovery, with uncertain growth in consumer spending and capital investment remaining weak for months.

At the Sept. 24 meeting, two of the 12 FOMC members -- Gov. Edward Gramlich and Dallas Fed President Robert McTeer -- voted in favor of an immediate rate cut. It was the first time a Fed governor had dissented in seven years.

The Fed's 11 rate cuts pushed down market interest rates. Automakers offered zero-percent financing on many new cars, which drove sales to record levels. Mortgage rates, too, fell to historic lows, keeping the residential construction and real-estate markets booming.

Throughout the recession, consumers maintained a steady pace of spending, an unusual occurrence in a most unusual business cycle. Consumers' incomes never faltered, due to a timely tax rebate and tax cut and to a relatively low unemployment rate even in the depths of the recession.

But now the evidence shows that consumers have become inured to low rates. Auto sales have fallen back. Retail sales have slowed. Consumer confidence has fallen to nine-year lows, as the bear market and war talk take their toll on consumer psyches.

Some worry that rate cuts wouldn't spur consumer demand because consumers are heavily indebted at the same time they are trying to save more to make up for the pathetic performance of their stock portfolios.

Consumer spending has propped up the economy, which has grown 3 percent in the past year. Growth is uneven, however. In the third quarter, spending on cars accounted for more than half of the 3.1 percent growth rate.

The low interest rates never really benefited businesses. The spread between Treasury yields and corporate bond yields widened, as creditors began asking tough questions about inflated balance sheets.

Companies didn't face a full-fledged credit crunch; neither was there much demand for credit to expand businesses. Companies had to work off their inventories first. Without a pickup in demand, companies had no incentive to invest in new buildings or equipment or to hire workers.

[TopQuark]

Most of these are inter-bank debt notes, with maturities of 30 to 90 days, but many with 6 months as well. When the Fed drop rates, the interest on these notes decreases, so the MM funds ge less revenue. Consequently, they pay less interest on deposits as well.

[Wyatt's Torch]

A "good thing" as in companies can no longer charge prices high enough to support their cost base so they cut costs (read - layoffs). That kind of a good thing?

[Grover_Cleveland]

Anyone know what's happenning to long-term interest rates?

[Grover_Cleveland]

So long as the speed of money doesn't slow down, deflation is a great thing. Everyone wants to be able to buy more with their money, after all.

But surely deflation (or, to be more accurate, an expectation of deflation) inevitably causes a slowdown in the speed of money?

[Willie Green]

For now, however, Americans are still spending, so we are nowhere near anything like Japan.

You need to keep up with current events.

Chain Store Sales Down in 4th Week October

Consumer Spending Falls 0.4 Percent

Consumer confidence plunges 14 points (lowest level in 9 years)

[Doctor Stochastic]

Small jump upwards since I last looked. Not much effect from the cut; probably already factored in.

[RightWhale]

The vote for such action was unanimous.

Is it possible for the entire committee to be completely wrong at one time?

Apparently so.

[On the Road to Serfdom]

If I am not mistaken, money market managers invest in equities

I think you are mistaken.

[justlurking]

Dang, and I just re-financed at 5 1/2%....

And I just refinanced at 5%.

[dakine]

Rub it in...

[Southack]

"A "good thing" as in companies can no longer charge prices high enough to support their cost base so they cut costs (read - layoffs). That kind of a good thing?"

You mean, is it good that Intel cuts the price of their computer chips every year? Yes. Is it a good thing that long distance and cell phone service gets cheaper every year? Yes.

Lowering prices is often a function of reducing one's own internal costs via productivity enhancements. That's just as true for the Intel's and Texas Instruments of the world as it is for American farmers, who buy better machinery that allows them to farm more land, faster, better, and cheaper than low-wage hand-hoers in Third-World countries.

It pays to become more efficient. Of course, there will always be a few Luddites who lament the demise of the cotton-picking jobs, but most educated men will eventually realize that all involved are better off when the machines multiply the labor of men.

To wit: my father went on a business trip to India some decades ago. He saw 1000 men digging a ditch with shovels and he pointed out to the supervisor that one man in a bull dozer could do taht work faster, better, and cheaper.

So the supervisor took my dad to another location where several hundred Indians were pounding rocks into powder for cement, using hammers.

Why are you showing me this nonsense, asked my dad. Because this is how we make sure that everyone has a job, replied the supervisor.

Laughing, my dad then told him that if he really wanted to employ more Indians, then he should replace the shovels with spoons and ban the hammers altogether. After all, we wouldn't want the men to be more efficient, right?!

Sadly, even in America we still have a few uneducated holdouts who think that improving efficiency is a bad thing. Don't let prices drop, they plead. Why, those cotton pickers/rock crushers/ ditch diggers might get laid off, they cry!

[justlurking]

Did the fed wait until after the election to spur the economy to make it harder for Bush ?

No, the Fed did the right thing by waiting until after the election.

If they had lowered rates just before an election while Clinton was in office, Republicans would rightly be screaming bloody murder.

[jiggyboy]

These Fed meetings are scheduled for Tue/Wed every six weeks, for what that's worth. I defer to the other posts in regard to action not taken at the last meeting six weeks ago.

[Wyatt's Torch]

Keep in mind that falling prices are just the symptom of deflation. Deflation itself is a decline in the monetary standard. A decline in this standard must result in falling prices (all prices) to meet this new standard. Prices fall at different rates depending on the contracts that surround them. That is why commodities (like gold, wheat, corn, etc.) fall first because they have the shortest contract length. Assets like real estate fall last because they have the longest contract lengths. The only answer is to increase the monetary standard back to previous levels which means adding liquidity to the banking system or reflating.

[fm1]

Thirty year treasury yields closed slightly lower..

[Southack]

"But surely deflation (or, to be more accurate, an expectation of deflation) inevitably causes a slowdown in the speed of money?"

Nonsense. Lowering the price of long distance phone calls, and likewise lowering the price of cellular phone calls, INCREASES the speed of money.

When the same Dollar buys more stuff (i.e. goods/services), then you have an incentive to buy.

The item that slows down the speed of money is fear, not deflation. When people are afraid, they might choose to hoard their money (so you'd notice things such as an increase in personal savings rates - a Japanese hallmark, for instance).

[ken in texas]

... 5% ?? Not bad at all. Would you mind telling me what the term length of the loan is? I have about 10 years to go on my loan but these rates are just about too low to pass up. Use a private reply if you want. Thanks.

[Wyatt's Torch]

This is not about the normal decreases in prices due to inefficiency and obsolescence (i.e. the high-tech industry). This is about getting people to buy your goods and part with their hard earned dollars. Why have the automobile companies been running 0% financing for 2 years now? Why is the real estate market softening? Why is the market refusing to go back up? It is all about finding the right price level.

BTW, what have INTL's revenues done over the past few years? Until Intel

[Vermont Lt]

Boy, say goodbye to your small bank stocks. The cost of funds ( your deposits) are almost zero. Who will fund the refinancing? Jeez, customers will be paying the banks to keep their money if this keeps going.

The margins between what the cost of funds are, and the return from loans is being compressed. That means increased fees and fewer services.

I,personally do not see this as great news.