Fed Cuts Rates 1/4 Point, Disappointing Markets

The Federal Reserve cut two key interest rates by a quarter point, disappointing financial markets, which were hoping for a half-point cut.

Ending a one-day meeting, the central bank cut both the benchmark federal funds rate and the discount rate by quarter point.

Steady if unspectacular hiring and signs the consumer has yet to fold suggest the economy, while cooling, has not entered a precipitous slide. At the same time, deteriorating conditions in financial markets recently led the Fed to make clear it saw risks rising and was ready to respond.

Pablo Martinez Monsivais / ASSOCIATED PRESS Federal Reserve Bank Chairman Ben Bernanke

"They now believe the dysfunctional credit markets present more risk to the economy and the financial system than anything found in the economic or inflation statistics," economists at financial services firm Wachovia Corp wrote in a note to clients.

"For the time being, the Fed will focus on righting the financial markets and making sure there is enough stimulus in place to offset the tightening in credit markets and ongoing unraveling of the housing market," they said.

Unease Over Housing

The U.S. central bank met against a backdrop of widespread unease over the sagging housing market and deepening gloom over exposure to delinquent mortgages at major financial
institutions around the world.

At its last meeting on Oct. 30-31, the central bank lowered rates by a quarter point, following up a surprisingly large half-point reduction in September. At the time, the October easing was "a close call," minutes of the meeting released later said, because evidence of a pronounced weakening of the broader economy was not evident to all policy-makers.
   
But since that decision, money center banks such as Citigroup, Bank of America, and HSBC
have announced billions of dollars worth of write-downs due to exposures to subprime mortgages. As financial market angst has spread due to the extent of subprime problems, lenders have restricted credit, fueling worries at the Fed.

"These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors," Fed Chairman Ben Bernanke said on Nov. 29.

Outside of the housing and financial services sectors, the U.S. economy has exhibited resilience. In addition to a steady labor market, many retailers reported stronger-than-expected November sales and a slumping dollar helped boost demand for U.S. exports.

Inflation Appears to Ease

Also, the risk of a flare-up in inflation -- which the central bank had cited as a reason for monetary restraint even as financial markets clamored for rate cuts -- appears to have
eased slightly. Productivity has been strong and core inflation gauges, which exclude volatile energy and food costs, have remained tame.

However, after a period of relative calm, credit markets are showing a level of strain not evident since August, when mounting defaults on U.S. subprime mortgages first led to a
worldwide pullback in money markets.

Thank you,

William Sorrentino Jr
ADVISOR



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