Skip to main content

Traders Scoff at Cut

Quarter-point cuts to two key rates were not enough, Street observers say.

Updated from 2:18 p.m. EST


Federal Reserve

disappointed the markets Tuesday by offering up a meek policy decision that seems both behind the curve and mired in inconsistency.

The central bank cut the federal funds rate a quarter-point to 4.25% and the discount rate 25 basis points to 4.75%. It is the third consecutive meeting that the central bank's Federal Open Markets Committee has slashed rates, amid unforgiving credit markets that make it difficult for firms to borrow money.

"Mr. Bernanke blew it," says James Bianco, president of Bianco Research. "The Fed should have cut the discount rate to the fed funds rate or lower."


Dow Jones Industrial Average

, which was flat ahead of the decision, plummeted almost 300 points after the Fed's decision, with the 10-year Treasury yield falling below 4% as investors fled risky securities to the safe haven of government bonds.

Bianco and many traders expected the Fed would cut the discount rate more than 25 basis points to help loosen the pressure on financial institutions, which have been reluctant to lend to one another. That's driven up market-based rates for overnight lending, such as the London Interbank Offered Rate. The Fed's discount rate is the interest rate that banks are charged to borrow money from their regional Federal Reserve Bank's lending facility.

Boston Fed President Eric Rosengren dissented with the rest of the committee, preferring to cut the fed funds rate by 50 basis points. This is the second meeting in a row that has had a dissenter in the mix. At the Oct. 31 meeting, Kansas City Fed President Thomas Hoenig dissented, preferring no rate cut. The committee cut 25 basis points at that time.

In its accompanying statement Tuesday, the committee refrained from taking on the easing bias that investors expected. The Fed left investors once again feeling rudderless, with a central bank that is unclear and divided on where the biggest risks to the economy may lie.

"While the committee did signal that it will act as needed, its refusal to focus exclusively on downside risks to growth leave an impression of a Fed that lacks a bit of confidence in its own outlook," write Joe Brusuelas, chief economist at IDEAglobal, who notes that Fed speakers of late have been varied in their outlooks for the economy as well.

The statement acknowledged some risks to growth, some risks to inflation, and mostly uncertainty about deteriorating financial market conditions. "The committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth," read the statement.

"All this says is 'I feel your pain,'" says Bianco. "I feel your pain is not working."

The policy statement stopped well short of saying the markets are in store for a period of rate cuts. Instead, it left one paragraph focused on growth, noting that "economic growth is slowing, reflecting some intensification of the housing correction and some softening in business and consumer spending."

On inflation, the statement said readings on core inflation have improved, but the familiar mantra was in place. The Fed noted that "elevated energy and commodity prices, among other factors, may put upward pressure on inflation."

But the committee didn't include the usual single sentence summation that clues the market into its thinking. The Oct. 31 statement read, "The committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth." Investors expected to see this turn into a balance that leaned toward the risks to slower growth, as many economists expect GDP growth to stall in the fourth quarter as the housing market continues to slide and business and consumer spending continue to slow.

"The Fed is a little behind the curve," says Thomas Higgins, chief economist at Payden & Rygel.

Traders say that the only thing that will help the markets is true credit markets relief, which some analysts argue the Fed can't offer with cuts in the fed funds rate. Analysts do note that lower short-term rates help steepen the yield curve, which does help financial institutions make money by collecting a wider spread from borrowing at cheap rates and lending longer term at higher rates.

But there's no question that recent victims of subprime- and credit-related troubles, including

Washington Mutual


, which on Monday

slashed its dividend and said it would look to raise $2.5 billion in a preferred stock sale to shore up its balance sheet, and

Bank of America


, which also on Monday

shuttered a $12 billion money market fund, need to see more light at the end of the subprime tunnel.

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.