Rate Cut a Small Bump on Market's Downhill Ride

SAN FRANCISCO -- Extraordinary times call for extraordinary measures, and the Federal Reserve took them this morning, at least theoretically.

The Fed announced a 50-basis point cut in both the fed funds and discount rates. The European Central Bank and Swiss National Bank also each cut their respective key lending rates by 50 basis points.

European bourses closed higher in reaction to the multiple rate cuts, the first true coordinated global easing since 1986. On Wall Street, however, the Dow Jones Industrial Average fell 7.1%, the S&P 500 shed 4.9% and the Nasdaq Composite declined 6.8%.

The Dow, which today joined other major averages in official bear market territory -- 24% below its closing high on Jan. 14, 2000 -- is now at its lowest level since December 1998. The S&P and Nasdaq are at levels not seen since October 1998.

Given the horrid nature of the events of last Tuesday and the four-day trading halt that resulted, today's large losses weren't considered shocking by most market participants. The New York Stock Exchange set a record for trading volume, at nearly 2.4 billion shares, and declining stocks swamped investors by 7 to 1 in Big Board activity and nearly 8 to 1 in Nasdaq trading. Otherwise, the session wasn't vastly different from other dramatic sessions the market has produced in recent years; for example, the Dow's point loss was its largest ever but in percentage terms did not even make the top 10.

Still, any hopes the Fed easing, in conjunction with an easing of corporate buyback restrictions, would buoy stocks were quickly dispelled as major averages only briefly rallied from their initial drop. Perhaps the declines would have been worse had the Fed not announced the intermeeting ease prior to the start of trading, but of course now, we'll never know.

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Gary B. Smith: Looking to the Past for Guidance

Calculating Potential Scenarios for the Dow

Patience Will Be the Virtue of the Week

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Tragedy -- and Retaliation -- to Strongly Affect Energy Sector

Cramer: Five Bullish Wild Cards

Sector Watch

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Defense Stocks Aren't the Sure Bets You Might Expect

If the Fed was attempting to "prop up" the stock market today, as many observers contend, wouldn't it have made more sense to ease in the midst of the session, rather than before the opening? That way, Alan Greenspan & Co. might have provided a catalyst to buyers, rather than having its rate cut seemingly consumed by the "natural" selling that was likely to occur today anyway. (Among others, veteran floor trader Arthur Cashin of UBS PaineWebber expressed a similar sentiment on CNBC today.)

"If they had only aimed the rate cuts at the market, those are points well taken. But the Fed had a dual purpose," said David Jones, chief economist at Aubrey G Lanston. One reason for the rate cut was to restore confidence in the financial markets, particularly the stock market, the economist said. But the second reason was the Fed's recognition that it needed to do more to stimulate the economy in the wake of last Tuesday's tragic events.

Jones believes the Fed would have cut rates by 25 basis points prior to its Oct. 2 meeting even if the terrorist attacks had not occurred, because of the "ominous signal" of consumer sentiment falling in the wake of the weak jobs report for August.

"It's inevitable now we'll see recession in the fourth quarter," he continued. "Given the circumstance, the Fed was right on the mark" with its 50 basis-point cut today and more rate cuts are likely.

Indeed, the fed funds futures contract is pricing in 100% odds of another 25 basis points at the FOMC's scheduled meeting on Oct. 2, and a 25% likelihood of a 50 basis-point cut.

Mickey Levy, chief economist at Banc of America Securities, agreed that that Fed action today was appropriate, "because the Fed's top priority is the safety and soundness of the banking system."

But rather than focus on what the Fed is saying, Levy suggested investors (and reporters) focus on what the Fed has been doing; pouring in a "huge amount of liquidity" in reaction to last Tuesday's horrific events.

Last week, the Fed injected approximately $125 billion into the banking systems -- $81 billion through its open market operations and another $44 billion through the discount window, according to BondTalk.com.

So, the Fed action today amounted to a public announcement of what it had already done, Levy suggested. "It had already eased [and] still clearly will continue to supply an unusually large volume of liquidity to financial markets."

After huge gains last week, prices of Treasury securities fell today, sending yields higher. Still, as represented by the yield on the two-year Treasury note, the cost of money remains below the Fed's new target rate of 3%.

More Fed action is likely to be followed by more announcements of rate cuts, although they may not have the salutary effect on stocks that some investors still expect.

On Friday I suggested Fed easing in conjunction with government spending could spur an economic recovery sooner than most observers currently contemplate. I certainly hope that proves true but my concern regarding today's Fed action is the same as it has been regarding much of its rate-cutting effort this past year: If a central bank takes "bold" and "decisive" action but proves to be ineffective, its credibility is weakened. The Fed has now cut rates eight times this year for a cumulative 350 basis points and, to date, failed to re-ignite the stock market for more than a few minutes or days, at best; thus, its ability to do so in the future is lessened.