Federal Reserve & Interest Rates

The Federal Open Market Committee, FOMC, made further cuts Wednesday at the January meeting.  This action is following surprise rate reductions that were made last week, when the Fed made an aggressive cut of 75-basis-points.

According to the FOMC statement, the federal funds rate was reduced by another half percentage point, and a half percentage point was taken off the discount rate.  The current federal funds rate is now 3% and the discount rate is at 3.5%.  “Financial markets remain under considerable stress, and credit has tightened further for some businesses and households.  Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.”

The forecasts seem to get worse and worse.  Reports on the fourth quarter GDP indicated a staggering drop in the rate of growth, 0.6% which is a dramatic slow down from 4.9% in the third quarter.  The Fed continues to have inflationary worries, although it is seemingly not at the forefront of concern.  “The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.”

The hope of these actions, according to the FOMC is to promote moderate growth over time.  Stocks responded to the cut, but didn’t close well by the end of the day, Wednesday.  U.S. Treasury bonds rose and stock futures eased.  The open the morning was poised for a week open.  We will see how the stocks perform now that confidence in continued rate cuts is strengthening.

If symptoms of recession persist, it is more than likely that the Fed will continue to cut rates for the first half of the year.  The statement said, “…downside risks to growth remain.  The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.”

Usually, the action is to reduce rates.  Inflation is still not under wraps, but those problems take a back seat to the dramatically slowed GDP growth, and the ever tightening credit conditions.  The liquid injections through the newly instituted TAF program is yet another attempt to resuscitate the economy.  $30 billion was released to winning bidders for a 28-day credit early this week.  Hopefully the TAF program will improved overall bank liquidity and help their ability to lend.

The rate cuts and the TAF auctions will continue.  Together with a possible fiscal stimulus plan, yet to be fully approved, we will see some signs of positive economic performance.  It can’t all be heading downward, can it?