Fed slashes rates to boost economy

The Federal Reserve lowers the target on a key short-term interest rate for the first time in four years to 4.75% from 5.25%
By Paul R. La Monica, CNNMoney.com editor at large
September 18 2007: 3:01 PM EDT
NEW YORK (CNNMoney.com) -- The Federal Reserve cut the target on a key short-term interest rate by a half of a percentage point Tuesday to 4.75%, further acknowledgment from the central bank that the mortgage meltdown plaguing Wall Street and Main Street could have a negative impact on the economy.
Stocks surged following the announcement, with the Dow gaining nearly 250 points, or 1.8 percent. The S&P 500 and Nasdaq both shot up more than 2 percent. Bonds fell, sending the yield on the benchmark 10-year U.S. Treasury up to 4.5 percent. (Bond prices and yields move in opposite directions.)
The cut to the federal funds rate, the first since June 2003, was widely anticipated by investors and followed a surprise cut to the Fed's discount rate on Aug. 17. The only question was whether the Fed would lower the federal funds rate by 25 basis points or 50 basis points. (There are 100 basis points in a full percentage point.)
Some investors had thought that Fed chair Ben Bernanke would take a more cautious approach and not cut rates by such a large margin, because a half-point cut could signal the Fed was acting out of desperation to save the economy.
But Alan Skrainka, chief market strategist with Edward Jones in St. Louis, disagreed with that interpretation. He said Wall Street was cheering the rate cut because it proves the Fed is willing to take any moves necessary to ensure the economy is not derailed by problems in the subprime mortgage market, loans made to consumers with less-than-perfect credit.
"We're having champagne and cookies," Skrainka said. "This is not a magical elixir that solves our subprime problems overnight, but it is a big step in the right direction to keep the economy growing. The Fed is sending a strong message that it won't get behind the curve," he added.
The federal funds rate, an overnight lending rate that banks charge each other, is important since it influences the amount of interest consumers must pay for various types of debt, such as credit cards, home equity lines of credit and auto loans. The rate cut should help some beleaguered home borrowers who are set to see monthly payments on adjustable rate mortgages rise later this year.
In its statement, the Fed said that "the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally" and that the rate cut "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."
The Fed also cut its largely symbolic discount rate by a half of a percentage point to 5.25 percent. The central bank lowered the discount rate, which is what banks pay to borrow directly from the Federal Reserve, by 50 basis points on Aug. 17.
Although investors applauded the rate cut, one market expert cautioned that this does not mean an end to the credit crunch.
"People should not assume that the economy's problems are over. That would be a mistake. They are significant and they are widespread," said Larry Smith, chief investment officer with Third Wave Global Investors, a Greenwich, Conn.-based investment advisor with about $400 million in assets. "Today's action, while important, do not put to rest the fears that emanate from the credit concerns."
But Smith said the rate cut was a "bold step" and that he expected the Fed to cut interest rates at least one more time, probably by just a quarter of a percentage point though, before the end of the year.
The Fed's next monetary policy decision is scheduled to take place at the end of a two-day meeting on Oct. 31 and its last meeting of the year is set for Dec. 11.
To that end, according to federal funds futures on the Chicago Board of Trade, investors are now pricing in a 100 percent chance that the Fed will cut rates at least one more time before year's end.
And Skrainka of Edward Jones said he expects the Fed to cut rates several more times during the next few months.
"This is the beginning of an easing cycle. This is not one-and-done move by the Fed."

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