Fed orders emergency rate cut, other banks follow

from Yahoo News:

WASHINGTON - The Federal Reserve, acting in coordination with other global central banking authorities, cut a key U.S. interest rate by half a percentage point Wednesday to steady a teetering economy.

The Fed reduced its key rate from 2 percent to 1.5 percent.

In Europe, which also has been hard hit by the financial crisis, the Bank of England cut its rate by half a point to 4.5 percent, while the European Central Bank sliced its rate to 3.75 percent.

Other central banks also taking part include the banks of Canada, Sweden, and Switzerland.

China also cut its key interest rates Wednesday for a second time in less than one month to stimulate slowing economic growth amid the global credit crisis.

The Fed's last rate cut was in late April, capping one of the most aggressive rate-cutting campaigns in decades as it scrambled to shore up the faltering economy. After that, the Fed moved to the sidelines, holding rates steady as zooming food and energy prices during that period threatened to ignite inflation. In the past few months, energy prices have retreated from record highs reached in mid-July, giving the Fed more leeway to drop rates again.

Lehman Brothers, the country's fourth-largest investment bank, filed for bankruptcy protection. A weakened Merrill Lynch, deciding it couldn't go it alone anymore, found help in the arms of Bank of America. American International International Group was thrown a financial lifeline. And, the last two investment houses — Goldman Sachs and Morgan Stanley — decided to convert themselves into commercial banks to better weather the financial storm. The number of banks that have failed this year are up sharply from last year. On Friday, Wachovia Corp. said it will be acquired by Wells Fargo & Co. wiping out Wachovia's previous plan to sell its banking operations to rival suitor Citigroup Inc.

Why the Fed's not done cutting rates---What is happening with a market?

The market is past its panic phase, but a grinding slowdown may soon put Bernanke back into easing mode.
By Colin Barr, senior writer

The market is eager to see Ben Bernanke heading for the sidelines. But with the U.S. economy softening, he may not stay there for long.

The Federal Open Market Committee is due to conclude a two-day policy meeting Wednesday afternoon. Trading in futures markets predicts the Fed will cut its key fed funds overnight lending target by a quarter-point, to 2%, and hold the line there in coming months. If the markets are right, the Fed is ready to go on hold for the first time since it began cutting rates last summer in response to troubles in the credit markets. The shift wouldn't come a moment too soon for some observers.

"Lower fed funds?" wrote Bill Gross, managing director at bond investor Pimco in Newport Beach, Calif., in his May investment outlook. "They would, in Pimco's opinion, likely do more damage than good from this point forward." Gross wrote Tuesday it's imperative that the Fed hold rates steady because "foreign and domestic investors are being fleeced with negative real interest rates, and the weak dollar, stratospheric commodity prices and steadily rising import inflation are the result."

But while surging food and energy prices have stolen the headlines this month, some observers believe falling house prices will force a substantial consumer retrenchment that could turn the Fed's attention back to economic growth. So while the Fed will surely be eager to show Wednesday that it hasn't forgotten that inflation is a concern, it could find itself cutting rates again later this year.

"The Fed is very likely going to find a way to signal a wait-and-see approach," Merrill Lynch economist David Rosenberg wrote this week. "That should not, by the way, be confused with an end-of-the-cycle approach."

For now, a pause in Fed action would be a welcome development after months of unrest. In addition to cutting the fed funds rate from 5.25% back in September, the Fed has expanded the scope of emergency loan programs to keep financial institutions lending to consumers and businesses. Since last month's Fed-brokered rescue of Bear Stearns (BSC, Fortune 500), fears of a default at rival brokerages such as Merrill Lynch (MER, Fortune 500) and Lehman Brothers (LEH, Fortune 500) have fallen sharply, judging by trading in the firms' credit default swaps.

But if Bernanke's policies have succeeded in easing the market's liquidity problems, signs of a slowdown in the United States economy have only become more pronounced. Rosenberg points to steep declines in home sales, retail sales and consumer confidence over the past three months. Merrill Lynch now expects second-quarter gross domestic product to fall 2.3% from a year ago, in the first quarterly contraction of U.S. economic output since the 1990 recession.

Rosenberg, who has been saying the Fed will cut its target rate as low as 1% during this cycle, isn't the only one talking about a prolonged slowdown. Merrill chief John Thain made a similar point in the firm's first-quarter earnings call two weeks ago. He said the firm believes the worst of the capital markets dislocation is past, but that related problems could just be coming to light.

"I think the real risk going forward here is how much do all of the problems in the financial and credit markets seep into the real economy," Thain said. "What is the impact of higher energy prices, higher food prices, higher unemployment, and falling home prices on the consumer and what's the impact of that in terms of the U.S. economy and ultimately the global economy?"

More bad news on the home-price front came this week, when Standard & Poor's said prices in 20 major markets dropped an average of almost 13% from a year ago in February. "There is no sign of a bottom in the numbers," said David M. Blitzer, chairman of the Index Committee at S&P. "Prices of single family homes continue to drop across the nation."

Falling house prices are likely to weigh on consumer spending, by preventing homeowners from funding consumption by tapping their home equity. That slowdown makes Dan Libby, a senior portfolio manager of the Sands Brothers Select Access Management fund, skeptical of the prospect that the economy will bounce back fast enough to permit the Fed to hold rates steady for long.

Libby said he believes Bernanke has staved off a deep recession and a market panic by acting as quickly as he did. But he said that he sees little sign that a strong recovery is at hand. While Libby said the Fed doesn't want to repeat its mistakes of the last cycle, when it left interest rates at very low levels even as economic growth picked up, he believes rates could fall to 1.5% before Bernanke & Co. are forced to confront a possible monetary tightening.

"I expect to see a slow, grinding muddling-through type of economy" for the next year or two, Libby said. He added that the Fed must "be careful about sounding too hawkish" when it issues its statement Wednesday laying out how it sees the risks confronting the economy.

That statement is what investors expect to be focusing on at 2:15 p.m. EST, when the Fed announces the results of today's meeting. "What is critical is what signal the Fed provides in the press statement," Rosenberg wrote this week, "and how much emphasis they put on inflation."

First Published: April 30, 2008: 3:42 AM EDT