Fed Rate Cuts May Go Even Deeper

Bernanke's moves show the central bank has adopted an approach different from under Greenspan.

Pigeons fly past the US Federal Reserve in Washington 30 January 2008. The Federal Reserve appeared set to deliver a fresh interest rate cut Wednesday to a struggling US economy just a week after an emergency easing, amid growing evidence of a slowdown.

The Federal Reserve appeared set to deliver a fresh interest rate cut amid growing evidence of a slowdown.

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Will this be enough?

That's the question Wall Street is asking after the Federal Reserve slashed interest rates today in dramatic fashion for a second time in eight days.

The Fed's latest half-point cut at the end of a regular two-day meeting follows a surprise three-quarter-point move on January 21. The unprecedented size of the combined cuts leaves no room for doubt that central bankers are doing whatever it takes to keep the U.S. economy from falling into a recession.

The Fed's statement included a warning that financial markets "remain under considerable stress" as tight credit conditions hit both business and the consumer. The Fed also sees "deepening" problems in the housing market as labor conditions—a longtime holdout despite a slowing economy—started to soften.

The latest decision to lower the fed funds rate to 3 percent from 3.5 percent shows that Fed Chairman Ben Bernanke and other policymakers are still very concerned about the possibility that housing and credit market problems will continue to plague economic growth this year.

Since September, the Fed has cut its key lending rate from 5.25 percent as problems in those sectors started to spill over into job growth and consumer spending. While lower interest rates often take several quarters to boost growth, analysts say the size and speed of the latest moves will be beneficial.

"It's a big help," says Stuart Hoffman, chief economist at PNC Financial Services. "Dr. Bernanke and his colleagues have given the economy quite a dose of medicine over the last week and a half."

Hoffman notes that Fed easing, mixed with a "shot of adrenaline" in the form of the $150 billion stimulus package currently working its way through Congress, could do much to keep the current economic slump from worsening.

The statement left room for the Fed to cut even more if problems persist, though most expect the pace of cuts to slow. Fed funds futures still predict rates will fall another half-point by the end of April as those housing pressures mentioned in the statement continue to hinder economic growth.

As it continues to lower interest rates, the Fed is choosing to focus on bolstering growth rather than dampening inflation pressures that still remain widely intact throughout the economy as prices for energy and food continue to edge skyward.

Much will depend on incoming data on jobs, growth, and housing—and there is little good news at the moment.

The latest figures on economic growth are troubling at best. In the fourth quarter of 2007, the economy expanded at a poor 0.6 percent pace, a far cry from 4.9 percent in the third.

The jobs picture may have brightened a bit if the latest report on payroll job growth from ADP is accurate. It showed a bounce of 130,000 new jobs in January, a rebound from December's dismal 37,000-job increase. The government's monthly jobs report is due Friday. Orders for big-ticket durable goods have perked up, too. However, home prices continue to fall with no bottom in sight.

Looking ahead, analysts also say this unprecedented round of rate cuts mark a shift in the Fed's strategy.

Under Bernanke, monetary policy has morphed notably into a tool for actively managing economic risks, a sharp contrast to the style of his predecessor, Alan Greenspan, whose policy announcements, while often cryptic, were viewed as reliable and predictable by markets and economists.

As such, the Fed's future policy moves will be tougher to predict, economists say.

"The Fed never cut at this speed under Alan Greenspan," says Ethan Harris, chief U.S. economist at Lehman Bros. "The Fed seems comfortable with the idea of pushing down really hard and taking it back later. They've embraced this risk management approach. Once you decide you're really in a war against recession, you do whatever it takes to stop it."

Also, the Fed's embrace of this risk-management strategy makes wise policy decisions in the future even more important. If rate cuts and fiscal stimulus have the desired impact and the economy avoids a recession, the Fed will have to be just as vigilant in hiking rates as it was in cutting, especially if a return to faster growth carries with it the possibility of a large surge in inflation. In the meantime, given the latest round of easing and expectations of more to come, the Fed has picked its battle. There will be others.

TAGS:
recession
interest rates
Federal Reserve
Bernanke, Ben
economy
  • Kirk Shinkle

    Kirk Shinkle is a senior editor for U.S. News Money and manages the Best Funds portal. Follow him on Twitter @KirkS or email him at kshinkle@usnews.com.