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Rate Cuts: Fastest Easing Of Monetary Policy Since 1990

Surprise, surprise. This afternoon, the Federal Reserve lowered the federal funds rate by 50 basis points to 3%. U.S. financial markets were hoping for a rate cut of this magnitude, and stocks responded by shedding earlier losses and climbing higher. The Fed also announced that it was cutting its discount rate (the interest it charges on direct loans it makes to banks) by a half-point to 3.5%. According to the Federal Open Market Committee statement issued at the end of the two-day meeting on interest rate policy:

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…

Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, 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.

There was only a passing reference to the threat of inflation:

The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully.

A number of analysts fear that the rate cuts will stoke inflation fires, resulting in much higher rates at some point in 2009.

The cumulative reduction in rates since January 22 has been the fastest easing of monetary policy since 1990. Hours before the decision was announced, the Commerce Department reported that gross domestic product grew at an annual pace of 0.6% in the fourth quarter, the slowest since the end of 2002. Consumer spending and business investments slowed slightly in the fourth quarter, while investments in houses fell at the fastest rate in 26 years. Businesses reduced their inventories, while exports grew at a slower pace as well. Art Hogan, chief market strategist at global investment bank and institutional securities firm Jefferies & Co., told MarketWatch:

If you look at the magnitude of the easing that has happened in the last week – you’d have to go back to 1990 to see as an aggressive move — it shows just how concerned the Fed is about the pace of the U.S. economy.

David Resler, chief economist at Nomura Securities International Inc. in New York, told Bloomberg:

They’re going full-bore trying to keep the economy from recession. There’s nothing in reserve here.

The “R” word is being mentioned more frequently on the Street these days. Wall Street firms such as Citigroup, Goldman Sachs, Merrill Lynch, and Morgan Stanley are all forecasting the first recession since 2001 this year. Prior to the Fed’s announcement today, global news agency Agence France-Presse reported that former Fed chair Alan Greenspan had doubts about the central bank’s ability to prevent a recession in the United States. In an interview to appear on Thursday, Greenspan told the German weekly Die Zeit that the Federal Reserve or political policies could “probably not” keep the U.S. economy from sliding into recession. Greenspan was quoted as saying:

The influences of the global economy today are stronger than almost any monetary or budgetary response…

Real long-term interest rates have much more influence over the heart of economic activity than national decisions. And central banks have less and less power to influence long term rates.

Greenspan thinks there is a 50% chance for recession in the United States.