In the aftermath of last week's terrorist attacks, the market has continued to suffer. Each time investors thought stocks had found their footing, it turned out that the hoped-for bottom was false. They aren't giving money away anymore, that's for sure.
Or are they? Actually, the irony is that the
Federal Reserve is doing just that right now.
Federal Open Market Committee cut the fed funds target rate to 3% from 3.5% Monday morning, it explicitly said that it would be pumping such large amounts of money into financial markets that actual overnight rates would be much lower. But nobody knew they'd end up being so low. The Fed has added to liquidity to such an extent that the real fed funds rate -- the rate at which banks with excess reserves at the Fed district banks will lend overnight to banks needing to meet reserve requirements -- has been at 0.5% or lower for the past two days.
"The Fed's printing money," says J.P. Morgan equity strategist Doug Cliggott. "If I was in their shoes, I'd be doing the same thing -- you open the doors and windows and say, 'Here you go.' You can't let a lack of liquidity be an excuse for forcing a business to shut down."
Particularly when many of the businesses most directly affected by last week's attacks are so important to the financial health of the country. Besides the banking system in general, the Fed's liquidity injections have been directed at the dealer community, much of which is, or was, housed in New York's Financial District.
"That extra liquidity goes to the dealer community fast and quickly spills around," notes Mike Cloherty, bond market strategist at Credit Suisse First Boston. Many other short-term credits are now trading well below the Fed's target rate. And while it seems unlikely the funds rate will remain under 1% for long, Cloherty thinks it will stay well below the target rate for some time.
Besides keeping the financial system from falling under duress, lower short-term rates should help stimulate the economy, both because they will help drive borrowing costs down and because they themselves offer such a low return on investment that money may seek out riskier assets. "It's not a magic bullet, but it sure doesn't hurt," concludes Cloherty.
Source: Federal Reserve
But while the low real funds rate will doubtless be somewhat stimulative for the economy, says Northern Trust Company chief economist Paul Kasriel, banks may not take advantage of the Fed's free money to the extent one might think. True, the funds rate may be low right now, but there's no way to know whether it could ride right on up to the target rate soon.
"Unless you can really count on it, it's not something you want to place big bets on," Kasriel says. "A bank is not going to extend credit based on this lower funds rate that, they don't know, could change tomorrow."
Particularly in an economic and political environment where taking on financial risk is an increasingly frightening thing to do.