Fed Cuts Rates by 50 Basis Points

In a move that's sure to disappoint the stock market, the Federal Reserve cut the fed funds rate by 50 basis points to 5% today. Whether the Fed would cut rates by 50 or 75 basis points was considered a toss-up, but the Fed opted for the smaller move, probably due to recent economic reports indicating a slowing, rather than a recession, in the economy.

Between Jan. 3 and now, the Federal Reserve has acted drastically in cutting interest rates, in order to spur borrowing and demand in the economy, which fell sharply in the fourth quarter of last year. The Fed has now lowered the fed funds target by 1.5 percentage points from 6.5%, where it stood before the committee undertook a surprise rate cut Jan. 3.

The move attempts to balance the signals being given in economic reports, which show a reasonable amount of demand in the real estate and automobile markets, as well as in the level of foreign demand, against the sharp declines in business investment and the steep drop in the stock market.

Economists interviewed over recent days expressed the belief that the equity market was indeed giving off the strongest warning signs about the economy, but Fed officials in recent weeks have indicated that the equity market alters their forecast only in respect to how it affects consumer confidence.

Consumer confidence has fallen significantly, but consumers' assessment of their job prospects and current spending habits have held up reasonably well, according to recent surveys. Their assessment, as well as evidence in other reports, is indicative of an economy with near-flat growth, but not one in a recession. Clearly, the Fed is viewing these reports as a sign that the economy will show a recovery in the second half of the year.

The outcome of today's meeting was a close call for sure. Of the 25 primary dealers in government securities (those who buy and sell directly to and from the Federal Reserve), 13 of them were expecting a 75 basis-point move, and 12 of them were looking for a 50 basis-point cut.

However, if anything, it's the 75 basis-point move that would have been a bigger surprise, because the reason for the move would have to have been explained by the weakness in the equity market, and the Fed doesn't like to be viewed as targeting equity prices.

The fed funds rate is the rate at which banks can borrow from each other. The discount rate is the rate at which banks can borrow from the Fed's discount window.

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