Fed Cuts Key Rates by 50 Points; Will Act as Needed

The Federal Reserve said Tuesday it unanimously decided to lower its key fed-funds target rate by 50 basis points to 4.75%. It also lowered its discount rate by 50 basis points to 5.25%, leaving a 50 point spread between the two rates. Economists, who had largely expected a 25 basis-point cut, were surprised by the boldness of the move -- the first rate cut by Chairman Ben Bernanke, who is generally considered moderate.

The Fed's willingness to move boldly despite limited evidence of a broad-based economic slowdown, coupled with its readiness to "act as needed to foster price stability," fueled hopes of further cuts in coming months. Federal-funds futures now show 60% odds that the FOMC will cut the fed-funds rate another quarter-percent to 4.5% at its Oct. 30-31 meeting. Before the decision, odds were only 12%. "They're on a downward path now," Pimco CIO Bill Gross said. "The question nobody knows is: how far do they go?"

Not all economists were buoyed by the move. Scott Minerd of Guggenheim Partners said the Fed's willingness to reverse its position so drastically over the course of 45 days, from a viligant stance against inflation to promoting growth, "raises serious issues" over the Fed's credibility as an inflation fighter.

Stocks rallied on the move: The Dow Jones Industrial Average rose 285, the S&P 500 was up 37, and the Nasdaq Composite Index gained 47 points. The financial sector was clearly buoyed by the move; 91 of 92 S&P financials are up following the announcement, as are 97% of all S&P 500 stocks. Homebuilder stocks also rallied: Hovnanian is up almost 11%; Beazer Homes gained 9.5%; Toll Brothers is up 6.4%; and Pulte Homes gained 3.4% after CEO Robert Toll commented, "Our boy (Bernanke) may be righting the ship." Gold hit a 27-year high of $735/ounce on the announcement. Oil made new highs, trading as high as $82 a barrel. The U.S. dollar lost more ground against others currencies; euro futures traded above $1.40.

Following is the condensed text of the FOMC statement:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4-3/4 percent.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth...

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 5-1/4 percent.

Sources: Press release, Dow Jones Newswires
Commentary: The Market's Unlikely To Take Any Fed Action Positively • A Look At Fed Easing Cycles In the Post-War Period • Are Stock Sectors Pointing To Stagflation?
Stocks/ETFs to watch: DIA, SPY, AGG

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