Fed delivers large US rate cut, markets rally

The Federal Reserve slashed United States interest rates by a hefty three-quarters of a percentage point on Tuesday, giving a lift to stock markets already jubilant over stronger-than-expected investment bank earnings.

Trying to avert a deep recession and financial market meltdown, the central bank cut less than many traders had expected but left the door open to additional reductions.

Two policy-makers voted against the move for fear of fueling inflation, underscoring the tough balancing act the Fed faces with prices rising on the back of a boom in commodities and energy costs.

”The Fed has shown that they are focused on getting the economy back on its feet first and foremost, and they will worry about inflation later,” said K Daniel Libby, senior portfolio manager at Sands Brothers Select Access Fund in Greenwich, Connecticut.

The move, which took overnight rates down to a three-year low of 2,25%, came after a host of emergency measures to breathe life into financial markets that the Fed hadn’t used since the 1930s. Fed chairman Ben Bernanke, a student of the Great Depression, on Sunday unexpectedly allowed direct Fed lending to securities firms and helped put together a rescue to keep Wall Street firm Bear Stearns from going under.

Stocks, already up on news that key Wall Street players Goldman Sachs and Lehman Brothers were in better shape than thought, extended their gains. In the end, the Dow Jones industrial average jumped 420 points, or 3,5%.

The battered dollar recorded its largest single-day increase against the yen in nine years and rallied against the euro, while safe-haven US Treasuries fell as investors regained confidence and poured into stocks.

”The Fed’s action is yet another forceful move in its attempts to alleviate the liquidity crunch and to shore up a rapidly weakening economy,” said Arun Raha, a senior economist with Swiss Re in New York.

Market, economic stress

The central bank has now cut rates by an aggressive three percentage points since mid-September, including two points since the start of the year. In addition, it has vowed in recent days to provide around $400-billion worth of liquidity to thaw frozen credit markets.

”Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters,” the central bank said. ”Downside risks to growth remain.”

A Reuters poll of 16 big Wall Street firms that deal directly with the Fed in the markets found that 10 expect the central bank to lower rates by a further half-point at its next meeting on April 29 and 30. The other six see a quarter-point cut.

The rate action came two days after the central bank announced up to $30-billion in financing to facilitate the sale of cash-strapped investment bank Bear Stearns, an unusual intervention bank officials said was necessary to prevent cascading defaults from damaging the entire financial system.

Concerns other financial institutions may also be running into severe trouble from mortgage-related losses were eased by the earnings reports from Goldman Sachs and Lehman, and both companies saw their stocks post record one-day gains.

Goldman, the largest Wall Street bank by market value, said its first-quarter earnings fell by half on steep losses on corporate loans and other assets. Still, the results exceeded the gloomy expectations of analysts.

Lehman, whose shares have been pummeled in recent days on worry it was the most vulnerable to troubled mortgages and leveraged loans next to Bear Stearns, suffered a sharp fall in bond trading revenue but benefited from a strong merger advisory performance.

While the Fed made clear it was most worried about deteriorating economic and financial conditions, it said it would also be keeping a wary eye on prices and expressed some nervousness that inflation might not decline as expected.

Those concerns appeared to weigh heaviest on Philadelphia Federal Reserve Bank President Charles Plosser and Dallas Fed chief Richard Fisher who argued for less-aggressive rate action and voted against the move — the first double dissent since September 2002. – Reuters

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