Fed cuts rates to 1%, markets disappointed

The Federal Reserve cut interest rates by a quarter-point on Wednesday and pointed to further determination to counter the danger that the United States would slide towards deflation.

Although the cut took the Fed funds rate to one percent, the lowest rate in the past four decades, it was nonetheless smaller than the market expectations and was accompanied by a muted statement that largely reiterated the Fed’s existing stance.

Despite the Fed’s move, global equities, commodities and bond markets sunk into the red yesterday, as investors reacted with disappointment to the rate cut overnight.

European stock indices were firmly in negative territory by mid-morning trade, tracing the movements of Wall Street overnight.

The downward move in the markets pointed to the investors’ worries about the Fed’s modest 25-basis point interest rate cut and the policymaker’s warning on deflation. The federal funds rate was lowered to a 45-year low of one percent. But traders in New York said investors were discouraged by the wording of the Fed’s statement.

“Recent signs point to a firming in spending, markedly improved financial conditions and labour and product markets that are stabilising,” the Fed’s statement read. “The economy, nonetheless, has yet to exhibit sustainable growth.”

While policymakers noted some improvement in economic conditions and stabilisation in labour markets, they said the economy had yet to exhibit sustainable growth. This sparked fears that the cut of 25 basis points was not enough to boost economic growth in the world’s largest economy.

The decision sparked a sell-off on Wall Street which sent the Dow Jones Industrial Average 1.08% lower by the close to 9,011.53, while the Nasdaq Composite ended 0.2% weaker at 1,602.3.

However, the dollar reacted positively to the reduction in the Federal funds rate by the US central bank, as investors decided to focus on the improving outlook highlighted in the statement accompanying the cut. The dollar rose against the euro yesterday morning in London trading to $1.1498 per euro, compared with $1.1529 late Wednesday in New York. Also, the US currency gained to 118.30 yen from 118.04.

The fall in the Fed’s benchmark rate will quickly reduce rates on many business, home equity and credit card loans, as well as the return on money market funds.

The Fed has cut rate 13 times since the beginning of 2001, first in a failed effort to prevent a recession and more recently in hopes of halting a period of slow growth and persistent layoffs. But the hangover from the 1990’s boom, combined with wars in Iraq and Afghanistan and a series of corporate scandals, has caused the worst hiring slump in 20 years and the longest one since the period before World War II.

georgiana.stavarache@zf.ro