Fed eyes further rate cut, steps to boost confidence

The US central bank, which led a coordinated global rate cut earlier this month that pushed its target rate down a half-point to 1.50 percent, is seen as trimming the rate another 25 to 50 basis points.

The Federal Open Market Committee headed by chairman Ben Bernanke is expected to announce a decision around 1815 GMT Wednesday at the close of a two-day meeting.

‘Recent history tells us the Fed always follows up an inter-meeting rate cut with another reduction at the ensuing FOMC meeting,’ said Joseph LaVorgna, economist at Deutsche Bank, who predicted a half-point cut to bring the rate to 1.0 percent, the level from June 2003 through June 2004.

‘Some market participants initially believed policymakers would try to reserve some ‘monetary ammunition' by only cutting rates 25 basis points -- a view with which we disagreed given the ‘shock and awe' tactics the Fed and Treasury seem to have recently adopted.’

Analysts say the crisis that began with a housing meltdown and credit crunch has now spread to the economy with a serious global downturn likely.

‘The Fed isn't going to sit still while this outlook unfolds,’ said Scott Anderon, economist at Wells Fargo.

‘We fully expect them to cut the Fed funds target rate to 1.0 percent ... and they could even follow that with direct purchases of longer-term Treasuries, corporate bonds or mortgage-backed securities if the Fed funds rate cuts don't do the trick of lowering the average interest rate on corporate and consumer borrowing.’

Yet analysts say the move would be largely symbolic because the actual rate of overnight interbank loans is in fact well below the Fed target because of the extraordinary efforts to pump liquidity into a strained banking system.

‘The cut is already in the market,’ said John Ryding, economist at RDQ Economics.

Ryding said a fresh rate cut is virtually certain ‘and the question is whether it's 25 or 50 basis points.’

Still, Ryding said the Fed target rate is largely ‘irrelevant’ during the current market turmoil, with the actual overnight rate since October 16 between 0.60 and 0.93 percent for these types of interbank loans.

‘The market is convinced the Fed will do something,’ said Cary Leahey, senior economist at Decision Economics.

‘We lean toward 25 basis points but we wouldn't be surprised to see 50. I think there would be resistance to lowering the rate below 1.0 percent.’

Cutting below 1.0 percent could be seen as a sign of panic, according to some analysts, and also would remind markets of the low rates in 2003 that fueled the massive housing market bubble. Also, a low funds rate could pressure some investment firms' money market funds, which might be unable to pay interest to investors after management expenses.

Bob Doll, chief investment officer at Blackrock, said the Fed cannot afford to stop being aggressive.

‘The dramatic steps taken in recent months have so far failed to stem the panic. Policymakers are passed the point where they will stop or even slow down, and we expect more programs to be rolled out until markets finally unfreeze,’ Doll said.

‘There is no question that the Fed has been aggressive in dropping rates, but that does not mean they are ahead of the curve. With 10-year bond yields at 3.5 percent, the fed funds rate may need to go to zero in order to get the steepness in the yield curve necessary to shore up the banking sector and the economy as a whole.’