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01/31 14:51

Fed Cuts Overnight Rate to 5.5%; Sees Weakness Risk (Update1)

By Noam Neusner

Washington, Jan. 31 (Bloomberg) -- Federal Reserve policy makers cut their benchmark interest rate by a half percentage point and said weakness threatens the U.S. economy's record expansion, signaling they're likely to cut rates again.

Fed Chairman Alan Greenspan and other members of the Open Market Committee reduced the target rate on overnight loans between banks to 5.5 percent. It was the Fed's second half-point cut this month, and was expected by investors.

With the economy slowing ``and with inflation contained, these circumstances have called for a rapid and forceful response of monetary policy,'' the FOMC said in a statement accompanying its decision. That suggests central bankers are prepared to cut rates again at their next meeting, March 20, should the economy's performance worsen.

Stocks were mixed and Treasury securities held earlier gains after the announcement, as investors had bet the Fed might cut rates more than they did. The implied yield on the federal funds futures contract for February, tied to today's action, had been as low as 5.40 percent before the announcement. After the announcement, the yield rose to 5.46 percent.

The Dow Jones Industrial Average rose 24 points, or 0.2 percent, and the Nasdaq Composite Index fell 2 points, or 0.1 percent. The Treasury's 10-year note rose 3/8 point, pushing down its yield 5 basis points to 5.17 percent.

More Cuts Expected

Investors are counting on the Fed to remain on high alert for signs of a recession. The implied yield on the June contract shows investors expect the Fed to cut rates by another half point by May and a further quarter point by July.

Government and industry reports show an economy suffering from declines in manufacturing and consumer confidence. The rate cut should boost the economy by making it cheaper for businesses and consumers to borrow. Immediately after the Fed's action, Bank of America cut the prime rate charged to its best corporate customers a half-point to 8.5 percent. Other banks were expected to match that move.

CSX Corp. Chairman John Snow said last week that a cut today would help create a ``short and shallow downturn rather than a deep and troubling'' one.

GDP Growth Slows

Earlier today, the Commerce Department reported that gross domestic product expanded at a 1.4 percent annual pace in the fourth quarter, the slowest in 5 1/2 years. Yesterday, the Conference Board reported that its confidence index fell in January to the lowest level in four years and registered the biggest monthly drop since the 1990-91 recession.

Since Jan. 2, the day before the Fed's surprise cut, major U.S. stock indexes have risen -- after falling last year. The Wilshire 5000 Index is up 8.5 percent; the Dow Jones Industrial Average is up 2.5 percent; Nasdaq Composite Index, comprised mostly of computer, software and telecommunications equipment makers, is up 25 percent.

The committee said ``the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future.''

The Fed's Board of Governors also voted to cut the discount rate on loans to banks from the Fed system by a half percentage point to 5 percent. Although few banks borrow directly from the Fed to meet their cash reserve requirements, the central bank generally keeps the discount rate within a half point of the overnight bank rate.

Making a U-Turn

Today's move is part of a U-turn in interest-rate policy that few investors expected two months ago. Until mid-December, the Fed had said inflation posed a greater risk to the economy than the possibility of a recession. At its Dec. 19 meeting, however, the Fed shifted its assessment and said economic weakness was now the bigger threat.

Since then, reports showed that manufacturing production fell 1.1 percent in December, the biggest decline in almost 10 years, and the decline in consumer confidence suggests consumer spending may fall, further curtailing demand to U.S. factories.

``We have had a very dramatic slowing down,'' Greenspan told Congress last week. ``We are probably very close to zero at this particular moment.''

Breaking a Pattern

With businesses trying to cut their stockpiles and consumers more fearful, the Greenspan-led Fed broke twice this month with its general pattern of changing interest rates in gradual steps of a quarter percentage point.

The Fed hasn't changed rates by a half-point in consecutive meetings since Greenspan became chairman in 1987. The last time central bankers changed rates by a full percentage point in a single month was in November 1984.

The slowdown has been worst for U.S. manufacturers. An index measuring factory activity in the Philadelphia area, considered a gauge of the nation's manufacturers, fell to its lowest since December 1990. DaimlerChrysler AG said earlier this week it will cut 26,000 jobs, or 20 percent of the workforce, at its U.S. unit amid falling demand for its Dodge Rams, Jeep Grand Cherokees and other models.

Job cut announcements have gathered force, and come from some of the same companies that generated economic growth over the past decade: WorldCom Inc., OfficeMax Inc., Amazon.com Inc., Lucent Technologies Inc. and AOL Time Warner Inc.

Other parts of the U.S. economy are having problems, too. Retail sales rose 3.4 percent in December from a year earlier, the smallest gain since February 1998. J.C. Penney Co. will slash about 5,500 jobs and close 47 stores to cut costs and rebound from five consecutive quarters of falling profit or outright losses.

The economy's slowing has cut into expectations for future corporate earnings growth. For the fourth quarter, 84 percent more U.S. companies warned that earnings would miss expectations than in the same period a year earlier, according to First Call/Thomson Financial. Already, 126 companies have issued warnings on first- quarter earnings, compared with 18 a year ago, the Boston-based firm said.

-- (M@rket.trends), January 31, 2001

Answers

M@rket.trends,

Thank you for the timely posting of market news.

I liked Greenspan's, "with inflation contained" comment. Who does he think he is snowing? The Fed has been creating money like there is no tomorrow, and when the foreign holders of all of those dollars start sending them home to us, we will experience price inflation like there is no tomorrow.

We will not have a soft landing this time. Greenspan's two aggressive 50 bp cuts in the month of January alone, tell the tale. This one is going to get much worse before it gets better.

-- J (Y2J@home.comm), January 31, 2001.

It is now 4:55 pm the market is NOT doing what it 'normally' does after a rate decrease, things that make ya go...

hmmmmm

-- sumer (shh@aol.con), January 31, 2001.

sumer,

This cut was expected, so the big/smart money players had been "buying the rumor", and today they "sold the fact".

The January 2nd cut took nearly everyone by surprise, and that is why the market went up sharply that day. Noone had a chance to "buy the rumor" before hand, because nobody had heard the rumor.

You are right in another way, also. These rate cuts have been so drastic, that they are making more than just a few market players sit up and think, "Just how bad is the economy, anyway?" for Greenspan to be cutting this hard.

-- J (Y2J@home.comm), January 31, 2001.