Fed slashes interest rates to lowest level since 1962

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Tuesday October 02 03:39 PM EDT

Fed Slash Rates Yet Again

By M. Corey Goldman ABCNEWS.com

Fed cuts interest rates by a half-point.

The Federal Reserve (news - web sites) slashed short-term interest rates by another half-point today, bringing them to the lowest levels since the Kennedy administration, in an effort to boost consumer and business spending and revive the downtrodden economy.

The Fed's policy setting arm, the Federal Open Market Committee (news - web sites), lowered its benchmark federal funds rate by a half percentage point to 2.50 percent, its lowest since May 1962. It also lowered the more symbolic discount rate by a half-point to 2 percent.

"The terrorist attacks have significantly heightened uncertainty in an economy that was already weak," the Fed said in its accompanying statement. "Business and household spending as a consequence are being further damped. Nonetheless, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate."

Financial markets registered little reaction to the move, with the Dow Jones industrial average and Nasdaq Composite index dipping slightly after the 2:15 p.m. ET announcement. They later recovered back into positive territory.

At issue, it seems, is how much more Fed Chairman Alan Greenspan (news - web sites) and Company can and will do to rejuvenate the ailing economy. "Looking forward, downside risks remain, and there is clearly no bar on further easing," said Ian Shepherdson, chief U.S. economist with High Frequency Economics.

Cutting Rates Aggressively

Prior to today's decision there was virtually unanimous consent on Wall Street that the economy needed another shot in the arm. Even before Sept. 11, the Fed was cutting rates aggressively in an effort to encourage consumers and businesses to borrow.

After last month's terror attacks that all but shuttered the U.S. economy and financial markets for a week, the Fed stepped in with a half-point cut on Sept. 17 to stimulate growth — and confidence.

But what remains uncertain is what kind of impact all these rate cuts might have on the fragile economy, which is experiencing an unprecedented amount of uncertainty as Americans brace for the possibility of further attacks at home and war abroad. And it is equally unclear how government spending in the form of tax cuts, bailouts and other incentives will work to pull the economy out of its funk.

Normally, the Fed lowers the overnight rate to push down the cost of consumer and business loans, stimulating purchases and boosting growth. The change generally trickles through financial markets and eventually to consumers by bringing rates on medium- and long-term bonds down — rates that are directly tied to consumer borrowing.

But these are not normal times. Even as the Fed has pushed its rate lower, the yield on the 10-year Treasury note, to which many mortgage and business loans are tied, has fallen only a half percentage point. The average rate on a fixed, 30-year mortgage was only about a quarter point lower than at the start of the year.

No Incentive to Borrow

The reason is that investors are not as keen to purchase long-term U.S. investments at the moment. And with long-term rates little changed, businesses haven't been encouraged to borrow, leaving the overall economy treading water.

"The Fed probably will continue easing until it has clear evidence of a self-sustaining recovery," said Salomon Smith Barney chief economist Kermit Schoenholtz.

Before Sept. 11, consumer demand was the saving grace to the economy's woes. Despite prevalent signs of economic weakness, consumers continued to spend on cars, homes, vacations and other peripherals that helped keep growth on the plus side through the second quarter of the year. Even then, there were questions as to how much longer the consumer could keep things going.

Unfortunately, the attacks definitively dealt with that. The U.S. economy, already struggling in the second quarter, probably shrank in the just-ended third quarter and is likely to do so in the fourth after the attacks depressed consumer and business spending, according to most analysts' predictions.

Today, President Bush (news - web sites)'s economic adviser, R. Glenn Hubbard, became the first administration official to forecast the nation's first recession in more than a decade. The textbook definition of recession is two consecutive quarters of negative growth.

Quagmire for the Fed

All that has left Greenspan and his fellow central bankers in a bit of a quagmire: Do they continue cutting rates, knowing the impact of each reduction takes anywhere from nine to 12 months to take effect, or do they sit back and wait for their previous rate cuts as well as various initiatives currently being pondered by Congress to kick in?

While most agree the added measures will work, not everyone agrees on how much is really needed or when the effects will make themselves known.

"The Sept. 11 attacks were an unprecedented shock to the system, but there's no doubt in our mind that this massive stimulus will work, promoting recovery by mid-2002 or sooner," said Steve Slifer, chief economist with Lehman Brothers. "The issue seems to be exactly what kind of combination of monetary and fiscal stimulus will spur that to happen, and when."

But William Dunkelberg, chief economist for the National Federation of Independent Business, sees things a little differently. "There's enough stew in the pot, we just have to bring it to a boil and see what it tastes like," he said, adding that he doesn't think the Fed should be lowering rates at all.



-- (M@rket.trends), October 02, 2001

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10/02 16:19

U.S. Economy: Fed Cuts Benchmark Rate, Cites Weakness (Update1)

By John Cranford

Washington, Oct. 2 (Bloomberg) -- Federal Reserve policy makers reduced the benchmark U.S. interest rate for a ninth time this year to its lowest level in four decades to boost business and consumer spending after last month's terrorist attacks.

Fed Chairman Alan Greenspan and his nine voting colleagues on the Open Market Committee lowered the target rate for overnight loans between banks a half percentage point to 2.5 percent. The Fed has never set a lower target, and the average monthly rate hasn't been this low since May 1962, more than 20 years before the Fed began using it to set monetary policy.

Central bankers have reduced the overnight rate twice, by a combined full percentage point, since terrorists destroyed the World Trade Center and disrupted business across the nation. As the Fed pushes rates lower, members of Congress and President George W. Bush are discussing a package of tax cuts and new spending to stimulate growth.

``The Fed is doing everything it can to stimulate the economy,'' said Steve LeBlanc, chief executive of Summit Properties Inc. ``Businesses haven't started to increase spending yet, consumers aren't increasing spending, and people are still in shock from the Sept. 11 tragedy.''

Charlotte-based Summit, which manages about 20,000 luxury rental units in the U.S., also develops apartments. ``We're capital intensive and we borrow money, so it's reduced our lending costs,'' LeBlanc said.

Additional Weakness

Central bankers warned the economy faces continued weakness, suggesting more reductions are possible in coming months.

``The terrorist attacks have significantly heightened uncertainty in an economy that was already weak.'' the Fed said in a statement accompanying its decision. ``Nonetheless, the long- term prospects for productivity growth and the economy remain favorable.''

J.P. Morgan Chase & Co., Bank of America Corp. and Bank One Corp. cut their prime lending rates from 6 percent to 5.5 percent after the Fed announcement, lowering borrowing costs on credit cards and for some business loans.

Stocks rose after the Fed's action. The Dow Jones Industrial Average gained 114 points, or 1.3 percent, to close at 8950.45. The Nasdaq Composite Index rose 12 points, or 0.8 percent, to close at 1492.20. The yield on the 5 percent Treasury note that matures in August 2011 fell 2 basis points to 4.51 percent.

As a result of the Fed cuts, the yield on two-year Treasury notes has declined more than 2 1/4 percentage points this year. Even so, the yield on 10-year Treasury notes, to which mortgage and many business investment loans are tied, has fallen about a half percentage point. With long-term rates little changed, businesses haven't been encouraged to borrow for expansion.

`Excess Capacity'

``The problem for corporations is excess capacity and the paucity of demand,'' said former Treasury Secretary Robert Rubin, now chairman of Citigroup Inc.'s executive committee.

Bush said today the economic stimulus plan he's working on with Congress must be big enough to boost the economy in the short term and small enough that it doesn't push longer-term interest rates higher.

The intent of the Fed's rate cuts and the administration's stimulus plan is to prevent a recession that many analysts say has already begun -- or at least to limit its depth and duration.

Sales at DaimlerChrysler AG's Chrysler unit were down 28 percent last month from a year ago, while sales of North American- built cars and light trucks fell 2.6 percent at General Motors and 9.9 percent at Ford. General Motors said it would reduced its fourth-quarter production target for North America by as much as 3.6 percent because of slowing sales.

AMR Corp., parent of American and TWA airlines, offered bonuses to frequent fliers and UAL Corp.'s United Airlines reduced some fares by half to lure travelers onto planes as September passenger traffic slid more than 30 percent. AMR, UAL and other airlines have announced almost 100,000 job cuts as travel slumped following the attacks.

No Precedents

``We don't have any historical precedent as a guide, which means the Fed needs to be pre-emptive to help to cushion the economy against the Sept. 11 shock, said Lynn Reaser, chief economist at Banc of America Capital Management in St. Louis. Reaser expects a half-point cut in November.

The attacks ``substantially reduced the growth rate of GDP in the third and fourth quarters of 2001, and increased significantly the likelihood that the economy is in recession,'' Glenn Hubbard, chairman of the president's Council of Economic Advisors, told the Senate Budget Committee today.

The Fed's move also pushes the overnight rate close to zero when inflation is taken into account. The consumer price index rose 2.7 percent over the 12 months through August, more than the overnight rate is now.

``Basically we're talking free money'' for the highest quality borrowers, said Diane Swonk, chief economist at Bank One Corp. in Chicago. ``That's highly stimulative. It might not save us from recession, but it will lead us into a boom later on.''

Aggressive Rate Cuts

The last time the Fed's overnight rate was this low, John F. Kennedy was president. The economy had been growing at almost a 7 percent pace for a year and interest rates were rising as the Fed applied the brakes.

The Fed has lowered its target rate 4 percentage points this year, the most aggressive pace of cuts since 1982, when it cut the overnight rate by 5 percentage points in a similar period.

Gross domestic product probably shrank at a 0.5 percent annual rate in the third quarter and is likely to contract at a 1 percent pace in the fourth, according to the median forecast of 30 economists surveyed by Bloomberg News. In the second quarter, the economy grew at a 0.3 percent rate, the weakest since 1993.

Preserving the record, 10-year expansion would require consumers to keep spending, because that accounts for two-thirds of GDP. And it means businesses will have to reverse course and start investing after cutting their purchases of new equipment and software for three straight quarters.

Confidence Falling

There are doubts about consumers, whose optimism plummeted in September to the lowest in almost six years, a survey by the Conference Board showed last week, and the lowest in almost eight years, according to a separate University of Michigan survey.

Analysts said confidence was already falling before the attacks on the World Trade Center and the Pentagon. A preliminary University of Michigan sentiment index, based on surveys before Sept. 11, had already showed a decline. The final Michigan survey, released Friday and covering the entire month, showed an even bigger drop.

Greenspan told Congress last month to go slowly in adopting an economic stimulus plan so the full economic effects of the terrorist attacks might be evaluated.

At the same time, he said, a package would need to be ``significant,'' amounting to as much as $100 billion, including about $45 billion already appropriated, to have the desired effect.

Corporate Tax Cuts

The plan Congress and Bush are considering may include a reduction in corporate taxes, extended unemployment benefits, a higher minimum wage and investment tax credits. Bush said after a meeting with congressional leaders that all must agree on the size of the plan before they can work on specific details.

Republicans in Congress and at the White House have said they favor tax reductions for corporations. Democrats want aid for people who lost jobs because of the attacks and for lower-income workers who didn't get rebates this year under Bush's $1.35 trillion, nine-year tax cut because they didn't earn enough to pay income taxes.

The Fed's Board of Governors also voted today to cut the discount rate on loans to banks from the Fed system by a half percentage point to 2 percent, the lowest since November 1958. Although few banks borrow directly from the Fed to meet their cash reserve requirements, in the days following the terrorist attacks, the Fed loaned $45.6 billion through its discount window. The central bank generally keeps the discount rate within a half point of the overnight bank rate.



-- (M@rket.trends), October 02, 2001.


When they reduce the interest rate to the same as 1929, then we'll know we're in trouble for sure.

-- (uh-oh@it's.coming), October 02, 2001.

...or at least equal to the interest rate today in Japan...

-- AStar (WhenYou@Wish.Upon), October 02, 2001.

hows your buttwipe stash?????

-- al-d. (dogs@zianet.com), October 03, 2001.

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