The Federal Reserve gave Wall Street what it expected yesterday, a quarter-point rate cut.
But investors had clearly been hoping for much more. The Dow Jones plunged, ending nearly 300 points lower at 13,432.
Since the days of Alan Greenspan, the US market – and markets around the world – have learned to put a lot of faith in the ability of central bankers to anaesthetise them against any possible economic pain.
But as the ‘Maestro’ himself now says (now he’s safely out of office), we’re entering an ‘Age of Turbulence’. The markets may be about to get a nasty shock…
Hopes of a half-point cut dashed
The Federal Reserve cut interest rates by a quarter point yesterday, taking the US base rate (or Fed funds rate) down to 4.25%. Although it was broadly what Wall Street had expected, many had been hoping for a half-point cut, and indeed, one member of the board did ask for a half-point cut.
And worse still for believers in the “Bernanke put” (the idea that the Fed will always be able to cut interest rates to save Wall Street from its own bad decisions) was the accompanying statement, which suggested that the Fed thinks this rate cut – the third since August – might be enough.
“Today’s action, combined with policy actions taken earlier, should help to promote moderate growth over time,” the statement read, while it also added that “some inflation risks remain.”
“The bottom line is that the market now senses a lack of concern on the part of the Fed and this leads to a heightened anxiety regarding the outlook for the economy,” said David Greenlaw of Morgan Stanley – the investment bank which on Monday predicted that the US now faces recession in 2008.
Central banking decisions are being ignored
But are interest rate cuts the solution? The big problem at the moment is that banks have stopped lending to one another because they need the money themselves and are terrified of what’s lurking in their balance sheets.
Interbank lending is pretty much ignoring central banking decisions at the moment – neither the Bank of England’s recent rate cut nor the Fed’s cuts have had a great deal of impact on London interbank offered rates (Libor).
Banks aren’t going to ease up lending criteria for as long as the concern over subprime continues – which will be a long time. So perhaps central banks should be concentrating on their key remit – trying to control inflation.
Oil prices are soaring. Food prices likewise. And China’s inflation problems are starting to become entrenched. Annual inflation hit an 11-year high in November of 6.9%. It was driven partly by a 56% surge in pork prices (a Chinese staple), but another worry was a 1.4% rise in non-food prices.
It doesn’t sound like much, but it’s the sharpest rise this year, and shows that all the things that economists like to shrug off - like food and energy prices – are starting to filter down to other prices. As Huang Yip of Citigroup told The Times, “the inflation issue has evolved into more of a macro-economic problem.”
As a major source of deflation across the world, this should be a worry to all developed economies who have relied on cheap Chinese goods to prop up their consumer debt mountains.
Fed needs to find its 'inner Paul Volcker'
As Martin Hutchinson says on Breaking Views, “instead of cutting rates to appease Wall Street, the Fed needs to find its inner Paul Volcker,” the Fed governor credited with quashing inflation in the late 1970s and early 1980s, who at one point raised the Fed funds rate to 20%. It hurt – a lot. But the truth is, there’s pain ahead for Western economies whatever central banks do. The decisions they make now will merely affect how long it lasts and how much damage is done.
Turning to the wider markets...
Wall Street sharply lower
London's FTSE 100 index closed 28 points lower yesterday, at 6,513, after a day of quiet trading ahead of the Fed's interest rate decision. Property companies including British Land weighed following Monday's news from New Star of a 17% fall in the value of its property portfolio since the end of July. For a full market report, see: London market close
On the Continent, the Paris CAC-40 was also lower, losing 26 points to end the day at 5,724. And in Frankfurt, the DAX-30 ended the day with moderate losses as well, down 23 points at 8,009.
On Wall Street, stocks closed sharply lower in reaction to the quarter-point cut in rates. The Dow Jones tumbled 294 points to end the session at 13,432. The Nasdaq was off 66 points at 2,652. And the S&P 500 was down 38 points at 1,477.
Asian markets tracked Wall Street lower today. The Japanese Nikkei was down 112 points, at 15,932. And the Hang Seng was 705 points lower, at 28,521, in Hong Kong.
Gold falls on rate cut
Crude oil had slipped back to $89.72 this morning and Brent spot was at $88.67 in London.
In reaction to the Fed's decision, spot gold fell as low as $796.70 today from $811.70 late in New York on Tuesday. But the metal had since edged back up to $805.75. Silver, meanwhile, was steady at $14.53.
In the currency markets, the pound had strengthened this morning and was last trading at $2.0421 against the dollar and 1.3911 against the euro. And the dollar was at 0.6810 against the euro and 111.24 against the Japanese yen.
And in London today, bingo-hall owner Rank announced that it is scrapping its second-half dividend as the smoking ban and restrictions on gambling payouts have seen sales stagnate. Rank shares fell by as much as 9.5% in early trade.
Finally, our recommended articles for today...
This credit contraction has a long way to go
- Those who recall the early 1990s - or even 1972 - will know just how painful a credit contraction can be for all concerned. And following an unprecedented period of expansion, it may well be worse this time round. John Robson and Andrew Selsby of the Onassis newsletter take a closer look at how the current contraction is unfolding here: This credit contraction has a long way to go
Does the Bank of England want the pound to weaken?
- For all the reasons cited by the Bank to justify last week's rate cut, sterling was not one of them. So where exactly does the tumbling pound fit into the MPC's calculations? To find out why Jeremy Batstone thinks weaker sterling may actually be part of their plans, click here: Does the Bank of England want the pound to weaken?