The Federal Reserve cut short-term rates by half a percentage point today, continuing its aggressive rate-cutting push. In its statement, the Fed said the economic picture was still tilted toward weakness, an indication that it may cut rates again at coming meetings.
The Fed dropped the key lending rate, known as the
federal funds rate, to 4%, its lowest level since May 1994. After flip-flopping a bit, the major indices were trading near their session highs about 45 minutes after the Fed announcement.
Today's cut marks the fifth time the Fed has lowered the fed funds rate this year as it tries to breathe life into the economy. Each cut, which included two surprise cuts announced between official Fed meetings, has been a half percentage point.
In its statement, the Fed said, "The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook, seems likely to hold down capital spending going forward." This, coupled with "the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy," the Fed added.
This statement is more subdued than the comments the Fed made at the time of its previous cut, the surprise intermeeting move on April 18. At that time, the Fed deemed that those same factors threatened "to keep the pace of economic activity unacceptably weak."
The Fed hasn't been this swift in cutting rates since the end of 1984. In September of that year, the key rate was 11.3%; by the end of December, it was 8.38% -- a 290 basis point cut. While the 250 basis-point cut this rate-cutting cycle is smaller, on a percentage basis it is more pronounced: a move from 6.5% to 4% is more than 38%, compared with just under 26% in 1984. At that time, the Fed's target was the money supply rather than the interest-rate target. The fed funds target is the rate Fed member banks charge each other for overnight borrowing and it sets the benchmark by which most other key rates are determined.
In taking its aggressive cutting action, the Fed indicates that it remains concerned the downturn in business investment and capital spending that has dragged the economy lower remains in place -- and will continue to bleed into the job market. Companies have been cutting payrolls in response to lower demand for their products and services. In April, the economy lost 223,000 jobs, the worst one-month decline since 1991.
In its statments in December and March, the Fed said that it would have to monitor closely the evolving economic situation. Surprise intermeeting rate cuts followed both statements. This time, the Fed made no mention of the need to closely monitor the economy. The omission this time seems to indicate that if more rate cuts are coming, they aren't likely to come in between meetings. The Fed next convenes for a two-day meeting beginning June 26.
In the past week, there was talk the Fed might elect to cut rates by just a quarter percentage point today as a way of informing the equity market it was concerned about an upward spiral in wages and prices that could ultimately lead to an inflation problem.
Long-term rates in the bond market have been rising in the last couple of weeks in anticipation of continued aggressiveness from the Fed, a sign the Treasury market believes both growth and inflation will be on the rise down the road. The fed funds futures contract, the best proxy for the bond market's estimation of future Fed policy, is even beginning to price in rate hikes by the end of the year.
But today's rate cut shows the fragility of the economic recovery has the Fed concerned enough to postpone worries about inflation.
With short-term rates two and a half percentage points lower than they were at the start of the year, many economists now expect the Fed will begin to ease off its current course of rate cutting. The fed funds rate is expected to bottom out at 3.75% or 3.5%, which means rates would fall only another quarter or half a percentage point.