By Jennifer Yousfi
The U.S. Federal Reserve yesterday delivered the half a point interest-rate cut the market was expecting yesterday (Wednesday) – and hinted that more reductions could come – but an afternoon rally was snuffed out by investor fears that economic conditions will continue to worsen and that bond insurers may be downgraded.
All three of the major U.S. indices ended the day in negative territory.
The blue-chip Dow Jones Industrial Average Index slumped 37.47 points (0.30%), to close at 12,442.83. The tech-laden Nasdaq Composite Index was down 9.06 points (0.38%), reaching 2,349.00. And the broader Standard & Poor's 500 Index skidded 6.49 points (0.48%), and finished the day at 1,355.81.
"I think it's important to recall that when the market gets what it expects it doesn't tend to celebrate, at least not in the long run, since the market is a forward pricing mechanism," Art Hogan, chief market strategist at Jefferies & Co., told MarketWatch.com.
Just one week after central bank policymakers surprised the U.S. securities markets with a three-quarter point rate cut – the biggest in nearly 25 years – members of the Federal Open Market Committee (FOMC) yesterday concluded a regularly scheduled two-day meeting with the half-a-percentage point cut to the benchmark Federal Funds Rate, lowering it to 3%. FOMC members also voted to lower the Discount Rate by an equal amount, reducing it to 3.5%.
The rate reductions had an immediate effect. M&T Bank Corp. (MTB) said it would decrease its prime lending rate from 6.50% to 6.00%, effect today (Thursday). SunTrust Banks Inc. (STI), Wachovia Corp. (WB), and Bank of America Corp. (BAC) announced similar moves.
The prime rate is the base rate that commercial banks use to price loans to their best and most creditworthy customers. As such, it's a key indicator of the cost of credit.
Stocks initially advanced toward higher ground yesterday afternoon, but the rally sputtered and then stalled over concerns that bond insurers Ambac Financial Group Inc. (ABK) and MBIA Inc. (MBI) faced credit downgrades – which will also affect the ratings on the bonds that they insured. The two companies will lose more money than they're currently predicting from guarantees they sold on complex mortgage-related securities, Bill Ackman, a longtime critic of the bond-insurance industry, told MarketWatch.com.
Both firms saw their shares drop by almost 20% in afternoon trading yesterday. Ambac shares fell 15.9%, while MBIA shares closed down nearly 13%.
"Recent information indicates a deepening of the housing contraction as well as some softening in labor markets," the Fed's statement read. The statement left room for future cuts, by noting, "downside risks to growth remain" and stating the Fed "will act in a timely manner as needed to address those risks."
Prior to the Fed announcement, the Bureau of Economic Analysis announced that U.S. gross domestic product (GDP) grew at a slower-than-expected 0.6% annual rate for the fourth quarter, and gained only 2.2% for 2007 – the slowest full-year growth rate since GDP advanced 1.6% in 2002. While analysts had universally expected a decline from third quarter's 4.9% rate, the reported figure was far worse than the consensus estimate that called for growth of 1.2%.
"The initial estimate of fourth quarter GDP growth, which is sure to change over the next two revisions, was ugly, but only on the surface," Joel Naroff, president and chief economist of Naroff Economic Advisors, Inc., said in a note to clients yesterday. "The housing sector fell so precipitously that it took 1.2 percentage points out of growth in the fourth quarter and one percentage point for the year."
Naroff felt the report was positive overall, as housing isn't likely to take a similar hit in 2008. And the trade deficit continues to decline on the back of a weak dollar as exports increase. Business spending also remained strong. The unemployment report will be released on Friday and if the job numbers are good, consumer spending could still help the United States avoid recession.
But the Fed didn't feel the same way.
Despite its surprise move just last week, the Fed cut the key interest rate again yesterday signaling it is ready to undertake an aggressive easing campaign to avoid a recession.
"The Fed has gotten religion and is going do what they need to do," Mark Vitner, senior economist at Charlotte, NC-based Wachovia, told Bloomberg News.
Recession is definitely what's on Wall Street's mind, but Money Morning Investment Director Keith Fitz-Gerald reminds us that inflation should be just as important to Federal Reserve Chairman Ben S. Bernanke.
"The consumers are taking the brunt of this in the wallet while the Beltway Boys are blithely going about their business as normal," he said in an interview. "They evidently don't have to pay for their groceries, their meals, their gas, their medical bills or anything else that the rest of us have to deal with."
The bottom line: The Fed's efforts may well be misguided, and focused on the wrong objectives, Fitz-Gerald said.
"The Fed is fighting a credit crisis when what we have is an economic one," he said.
With consumer price inflation running at an annual clip of better than 4% for the past 12 months, a 3% interest rate isn't going to keep pace with inflation. As we noted yesterday, creating a negative real interest rate could have lasting repercussions while creating a host of new problems that will have to be addressed.
But Naroff feels the Fed's action today could be its last – unless the economy continues to weaken.
"I have consistently argued that we could skirt a recession and a 3.00% funds rate could be low enough to get the job done," he said in a note to clients after the Fed's announcement.
The FOMC's next meeting is scheduled for Mar. 18.
News and Related Story Links:
Mortgage rates could rise, not fall, after Fed move.
- Money Morning:
Three Ways to Profit in the Face of Surging Inflation.
U.S. Stocks Close Lower as Fed-Fueled Rally Unravels; Talks of Downgrades for Bond Insurers Adds to Insurers Adds to Late-Session Losses.
- Money Morning News:
Fed Fans Optimism and Fears With Surprise Rate Cut.
MBIA, Ambac slump on Ackman loss estimates.