The Federal Open Markets Committee (FOMC) made an intra-meeting announcement cutting the Federal Funds Rate Target 75 basis points to 3 ½% and a similar cut in the Discount Rate to 4%. The FOMC justified the move because "broader financial markets have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets."
In a separate move, the Canadian Central Bank also announced a rate cut as well.
This emergency move was made ahead of a FOMC meeting next week and after global markets around the world tumbled during the Martin Luther King Day holiday when U.S. markets were closed.
I believe that this move was made to re-establish the idea of the Fed as the lender of last result: the Bernanke Put. Initially, the Fed was reluctant to cut rates for several reasons:
- It was viewed as bailing out the stock market, not the economy;
- There were inflationary pressures from rising all prices;
- U.S. exports largely resulting from a falling dollar seem to be cushioning any drop in the economy.
However, these reasons have disappeared during the last month:
- Unemployment has jumped, increasing the possibility that the United States is entering a recession. There are valid economic reasons consistent with the Fed mandate for full employment to cut rates;
- Oil prices have receded making inflation less of an issue in the near term;
- The turmoil overseas if it continues could negatively impact U.S. exports and worsen the economic situation.
The evidence for Fed action has been building. If the FOMC had not taken action, confidence in the Fed's ability to cushion any downturn would continue to weaken. This action is the first step in re-establishing this confidence. This may be only the initial step in this process. We will learn more at the FOMC meeting next week.
Doug Roberts is the Founder and Chief Investment Strategist for FollowtheFed.com, an independent research firm focusing on investment strategies using the Federal Reserve's impact on the stock prices. He previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.
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