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Investors Want More Interest Rate Cuts

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[January 31, 2008]  WASHINGTON (AP) -- Federal Reserve Chairman Ben Bernanke, criticized last year for being too tentative in cutting interest rates, has shown he can act boldly. But the Fed's two aggressive rate cuts in the past eight days have left investors demanding still more.

That may be a sign of how much trouble the economy is facing, with many analysts contending that the country is flirting with a recession and may, in fact, already be in one.

The Fed announced Wednesday that it was cutting its federal funds rate, the interest that banks charge each other, by a half-point, double the quarter-point cut that many economists had been expecting. That move followed on the heels of a reduction last week in the funds rate of three-quarters of a point, which had been the biggest single rate cut in more than two decades.

Initially, the Dow Jones industrial average was up by more than 200 points after the Fed announcement, but then investors pulled back and the Dow finished the day down 37.47 points, indicating lingering worries about the economy.

All the changes mean that the funds rate, which stood at 5.25 percent in early September before the Fed started cutting rates, now is at 3 percent. The Fed is hoping the lower rates will stimulate the economy through increased borrowing by consumers and businesses.

While Bernanke and his Fed colleagues were criticized last year for giving the appearance that they were cutting rates only grudgingly, the January rate cuts have signaled that the Fed is in full-blown crisis mode.

The 1.25 percentage point reduction in the funds rate in just over a week is unprecedented in recent memory. The Fed hasn't been that aggressive about cutting the funds rate since the early 1980s, when then-Chairman Paul Volcker was reversing a tightening cycle that had driven interest rates to the highest levels since the Civil War in a successful effort to break the back of a decade-long bout of inflation.

In its statement Wednesday, Fed officials said its string of rate cuts "should help to promote moderate growth over time and to mitigate the risks to economic activity."

Analysts saw that language as an effort to tell markets that just because the Fed slashed rates in January, such bold actions should not be expected in the future. But those words could very well fall on deaf ears.

"The markets felt the Fed had fallen behind the curve. That caused a loss of credibility," said David Jones, chief economist at DMJ Advisors. "Once the Fed loses credibility, it can be hard to regain it."

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Investors are already betting that there are more rate cuts to come. A futures contract tied to the federal funds rate is projecting that rate could get down as low as 2 percent this summer.

The Fed's next meeting is March 18 and that will be followed by meetings in April and June. Many analysts said the Fed could trim the funds rate by a series of quarter-point moves during that time period, especially if the economic data remains weak.

The government reported Wednesday that the overall economy, as measured by the gross domestic product, grew at a barely discernible 0.6 percent rate in the October-December period. The fear of some economists is that the GDP rate could slip into negative territory in the current quarter. By one definition, a recession occurs when the GDP is negative for two consecutive quarters.

While the Fed is not publicly forecasting a recession, Bernanke and other officials have said they expect to see a period of slow growth, reflecting the impact of the severe housing slump and the credit squeeze which hit last August.

"Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," the Fed said in explaining Wednesday's rate cut.

"The Federal Reserve is obviously very nervous about what is going on in the financial system and the housing market," said Mark Zandi, chief economist at Moody's Economy.com.

While Fed officials were widely viewed as being slow to react last fall, analysts said they are now making up lost ground.

"The Fed misjudged the problems in the economy and the financial system through the Fed's December meeting. They just underestimated what was going on," Zandi said. "But I think they caught up in January and now they are fully engaged."

Zandi predicted a series of quarter-point rate cuts at upcoming meetings, but he said if the financial system begins to unravel, the Fed will return to more aggressive half-point rate reductions.

[Associated Press; By MARTIN CRUTSINGER]

Copyright 2007 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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