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To Cut, or Not to Cut?

The FOMC minutes seemed to reassure traders the central bank cares.

Updated from 1:37 p.m. EST

The mortgage markets were dealt another massive blow Tuesday, leading investors to again scream for the

Federal Reserve

to act, or at least acknowledge the pain.

Tuesday's stock market rebound -- amid choppy trading -- was bred out of speculation that the Federal Open Market Committee would hold an emergency meeting to cut the Fed funds rate. The cut would be a response to government-sponsored mortgage giant

Freddie Mac's


funding woes, say some market participants.

But all Tuesday had in store from the Fed was the 2:00 p.m. release of the minutes from the Oct. 31 FOMC meeting.

In the minutes, the Fed offered investors reassurance that the central bank will be compassionate when it comes to its Dec. 11 decision on interest rates. The fed funds futures market quickly ramped up odds to over 90% for a rate cut in December from as low as 72% earlier Tuesday, according to Miller Tabak.

The Fed focused on heightened risks to the growth of the economy, noting that coming quarters would be weak on the back of financial market turmoil, tighter credit conditions, and deeper deterioration of the housing market.

"Most members saw substantial downside risks to the economic outlook and judged that a rate reduction at this meeting would provide valuable additional insurance against an unexpectedly severe weakening in economic activity,'' read the minutes.

But expectations for an emergency cut are unlikely to fall away.

"There should be rumors of an emergency rate cut," says James Bianco, president of Bianco Research. "This is exactly the environment that they do it in."

Bianco is referring to speculation Tuesday that troubled mortgage lender

Countrywide Financial


could face greater liquidity problems tied to Freddie's

$2 billion loss and admission that it is having trouble maintaining its regulatory capital minimum.

This news sent Freddie's shares down nearly 30%, while fellow government sponsored entity

Fannie Mae


likewise fell 25%. Countrywide shares fell 2.7% by the end of the day, but they had plunged as far as 20% before a spokesman for Countrywide came out to say the firm has "

ample liquidity."

The danger, nonetheless, is that mortgage lenders like Countrywide, who have been relying on selling conforming mortgages to Fannie Mae and Freddie Mac, may find Fannie and Freddie aren't interested in buying, says Bianco.

And while the Fed continues to speak as though its course of monetary policy is based on the typical growth and inflation balance of risks, the real driver of monetary policy is fixed-income market confidence, he adds.

The more dovish stance evident in the minutes of the Fed meeting suggest the central bank may not be quite as far off from Wall Street's concerns as previously thought. Earlier Tuesday, T.J. Marta, fixed income strategist at RBC Capital Markets, summed up sentiment on bond desks by accusing the "Fed

as coming as close to fiddling while Rome burns as Nero ever did."

Marta was referring to the most recent Fed official rhetoric, which appeared tailor-made to steer markets clear of expecting more rate cuts.

"The current stance of monetary policy should help the economy get through the rough patch during the next year, with growth then likely to return to its longer-run sustainable rate," said Fed Board Governor Randall Kroszner, in a speech.

St. Louis Fed President William Poole said in an interview last Friday that given fourth-quarter data thus far and the 75 basis points already cut by the Fed, "the fourth quarter is going to be irrelevant to the December decision unless it tells us something about next year we don't already know." Earlier this month, Poole said he believes financial market turmoil would resolve itself and return to normal.

The credit markets are hardly back to normal. They are reeling to near-August panic levels or beyond, says Marta, citing relatively persistent flight-to-quality trade in Treasury bonds, selloffs in commercial paper markets, corporate bonds, and rising rates on Libor, or the London interbank offered rate. That means banks are anxious and raising the rate at which they'll lend money to other banks -- an August redux.

If it really is August all over again, investors should keep their eye on the Fed's discount window.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


to send her an email.