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Fed Cuts Rates by 75 Basis Points Amid Market Turmoil

22 Jan 08

The Fed today cut the federal funds rate by 75 basis points to 3.50% in the first emergency move since 2001. The prospect of at least a mild U.S. recession suggests that it is far from done cutting rates.

The Federal Reserve this morning cut the federal funds rate by 75 basis points, from 4.25% to 3.50%, in the first emergency inter-meeting rate cut since 2001. There was one dissent, from William Poole, who argued that the Fed should not take action before next week's regularly scheduled meeting.

The Fed also cut the discount rate by 75 basis points, from 4.75% to 4.0%. Only two regional banks, Chicago and Minneapolis, made requests for a discount-rate cut. Logistics may have made it impossible for all of the regional banks to make formal requests so quickly.

The Fed did not directly reference Monday's global stock-market meltdown in its announcement, merely noting that "broader financial market conditions have continued to deteriorate." It focused upon the weakening outlook for U.S. growth.

The Fed's focus makes sense, because although the plunge in global equity markets on Monday was the trigger for the Fed move, it was not the underlying cause. Both the financial markets and the Fed are responding to the increasing risk of U.S. recession and the danger that the United States will pull the rest of the world down.

The weakening in U.S. indicators since the beginning of the year has suggested that at least a mild U.S. recession is now more likely than not, and that vigorous Fed rate cuts are warranted. The plunge in global markets has prompted immediate action, instead of waiting until the next scheduled meeting on January 30.

Where do we go from here? The Fed's announcement today said that "appreciable downside risks to growth still remain." That suggests a strong bias toward more loosening, which appears well-justified given the threat to both U.S. and global growth. Fiscal policy will likely kick in later in the year, but for the moment, monetary policy is the only weapon available.

We now expect the Fed to cut another cumulative 100 basis points off interest rates, which would take the federal funds rate down to 2.50%. The next installment will probably come at the formal meeting on January 30—another 25 or 50 basis points. We would expect to hit 2.50% by the April 30 meeting.

by Nigel Gault

 
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