Fed-Led Global Intervention Gives Investors New Hope the Day After Rate Cut Disappointment

By Jennifer Yousfi
Managing Editor

Investors who were disappointed by Tuesday's quarter-point rate reduction by U.S. Federal Reserve policymakers were energized yesterday (Wednesday) when the central bank announced a plan to inject $40 billion in liquidity into the short-term credit markets.

The announcement - made before the opening bell on Wall Street - represents the largest coordinated global financial intervention initiative since the 9/11 terrorist attacks, eclipsing even the repeated capital infusions engineered this summer when the subprime mortgage crisis first roiled the worldwide financial markets. Working in concert with the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank, the Fed will raise as much as $40 billion in new capital via auctions to U.S. lenders. The U.S. central bank also announced  "temporary reciprocal currency arrangements," or swap lines - worth $24 billion - to make U.S. dollars available in European markets. 

This was the news the markets needed to dispel the disappointment resulting from Tuesday's decision by the policymaking Federal Open Market Committee (FOMC) to reduce the two benchmark interest rates by only a quarter percentage point. The FOMC opted to cut the Federal Funds Rate to 4.25% and the Discount Rate to 4.75. While the quarter-point Fed Funds cut was widely expected and had largely been priced into the market, many analysts had predicted a half-point reduction to the Discount Rate.

What may have spooked the financial markets following the rate reductions Tuesday was an accompanying FOMC statement that seemed to suggest that further rate cuts might not be necessary. "Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time," the central bank policymakers said in a statement. The statement went on to acknowledge a continued risk of inflation due to escalating fuel and commodity costs, despite a relatively stable core Consumer Price Index (CPI).

As Money Morning reported Tuesday, the financial markets reacted badly to the rate cuts and the FOMC's cautious language in its statement - with key indices recording their biggest declines in a month as investors worried the reductions weren't enough to stave off a U.S. recession and that there might be no additional reductions in short-term interest rates. On Tuesday, the Dow Jones Industrial Average plunged 294.26 points, or 2.14%, to close at 13,432.77. The much-broader Standard & Poor's 500 Index fell 38.31 points, or 2.53%, to close at 1,477.65. The tech-laden NASDAQ Composite Index skidded 66.60 points, or 2.45%, to close at 2,652.35.

However, many investors regarded yesterday's announcement about the Fed-led capital infusion as a positive sign the central bank was willing to take aggressive action to stem the continuing credit crisis. "They had to do something. Now that this has happened we can spend less time adding up the numbers and instead think of this as a sentiment-changing moment, when central banks tackled the problem aggressively,'' Fred Goodwin, a fixed-income strategist at Lehman Brothers Holdings Inc. (LEH) in London told Bloomberg.

Others credited central bank Chairman Ben S. Bernanke with his innovative solution to the current credit crunch.

"Bernanke has indicated he will take chances and be creative and think openly and act aggressively," Tony Crescenzi, the chief bond strategist at Miller Tabak & Co., said during a telephone interview with MarketWatch.com.

News of the liquidity boost was met favorably in the markets with all three major indices showing gains for the day.   The 30-stock Dow gained 41.13 points, or 0.31%, to close at 13,473.90 - recapturing about 14% of its losses from Tuesday. The S&P 500 forged higher by 8.94 points, or 0.61%, to close at 1,486.59. And the tech-laden NASDAQ jumped 18.79 points, or 0.71%, to close at 2,671.14.

"The course the Fed was on [just] didn't seem to be working," Doug Peta, a New York-based market strategist at J&W Seligman & Co., told Bloomberg. "We've got this new medicine we can try. I think we all can celebrate that."

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