Fed Cut Euphoria, But Will It last?

Source : TODAY, Thursday, September 20, 2007

World markets rally, analysts look ahead with mixed sentiments

WASHINGTON — For months, he had been criticised for being too cautious in responding to the stress in capital markets unnerved by the United States sub-prime loan crisis. But on Tuesday, Federal Reserve chairman Ben Bernanke proved that like his legendary predecessor Alan Greenspan, he, too, could be a friend of the markets.

At a meeting of the Fed's policy-setting Federal Open Market Committee, Mr Bernanke got unanimous agreement among his colleagues — some of whom had been sceptical about the need for such a move — to cut its key federal funds rate for the first time in four years, to 4.75 per cent from 5.25 per cent.

The larger-than-expected cut surprised many economists and sent stock markets around the world northwards. For investors, the Fed's bold cut was a welcome sign to reassure markets that have been volatile in the past couple of months. Investors had been worried that tightening credit conditions, sparked by rising defaults on sub-prime mortgages in the US, might trigger a recession in the American economy — a vital export market for Asia.

On Wall Street, the Dow Jones Industrial Average skyrocketed to end up 335.97 points, or 2.51 per cent, at 13,739.39.

Asian key markets were thrilled, too, with the Nikkei 225 index in Japan rising 3.7 per cent to close at 16,381.54, while Hong Kong's Hang Seng Composite closed at a record of 25,554,64. In Singapore, the Straits Times Index gained 3.4 per cent, or 116.61 points, to close at 3,594.36 yesterday. European stocks also climbed the most in a month.

In Manila, Asian Development Bank president, Mr Haruhiko Kuroda, said the US rate cut will "definitely sustain the strong economic growth in the US, which is beneficial to emerging economies in Asia".

Indeed, oil prices also rose yesterday on the back of the same expectations — that the cut will revive the US economy and strengthen demand for already tight crude and petrol supplies. Crude oil traded above US$82 a barrel in New York for the second day yesterday.

In a statement accompanying the rate cut, the US central bank acknowledged that the risks of a recession were too big to ignore.

"The tightening of credit conditions has the potential to intensify the housing correction and restrain economic growth more generally. Today's action is intended to forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets."

Leaving the door open for the possibility of more cuts, the central bank said it would "continue to assess" the economic outlook and "act as needed to foster price stability and sustainable economic growth".

At the same time, the Fed noted that "some inflation risks remain" — which suggests that the Fed may reverse its move should the US economy strengthen.

"The important policy debate now centres on the future interest rate path, but Fed officials left that more ambiguous," said Mr Richard Berner, chief US economist at Morgan Stanley.

While markets have welcomed the Fed's rate cut, some economists pointed out the move, while perhaps of some help, will not cure problems in the ailing housing market, which are expected to drag well into next year.

"I think the honeymoon is going to be pretty short for the euphoria of this Fed cut," said Mr Greg McBride, senior financial analyst for Bankrate.com. "A half-point cut can only do so much. It doesn't transform the housing market into sunshine and daffodils."

Others say the Fed move might send the wrong signal by bailing out those who contributed to the US housing bubble and encourage future market excesses. However one may view Tuesday's rate cut, this much is certain: Investors and Fed-watchers will start to view Mr Bernanke, who took over as Fed chairman last year, in a different light.

Much to Wall Street's chagrin, the former Princeton professor, a champion of steady rules to guide monetary policy, seemed to be more sceptical about reacting to financial turbulence than Mr Greenspan.

Mr Bernanke, for example, had earlier made it clear that he did not want to rescue investors or real estate speculators who made bad decisions.

But he apparently decided to that it was time to give the markets the rate cut they had been clamouring for after the August employment report showed that the US economy lost jobs for the first time in four years.

In doing so, he was acting very much like Mr Greenspan — reducing interest rates to pre-empt an economic slump, rather than waiting for one to occur.

Others believe that Mr Bernanke also wanted to challenge the prevailing view on Wall Street that he was not able to respond with sufficient boldness when the situation called for it.

"I think he resoundingly bashed those criticism on Tuesday," said Mr Mark Zandi, chief economist at Economy.com. "It was a very strong, clear statement that the Federal Reserve stands ready to do what is necessary to make sure the expansion stays on course."