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Below is today's Money Daily analysis of the rate cut. Everything I read
points to serious worry by the Fed. Is there a big default coming up
perhaps?
JW
abprosys@xxxxxxx <mailto:abprosys@xxxxxxx>
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For an enhanced HTML version of the Money Daily,
visit http://moneydaily.com.
Friday, October 16, 1998
The Fed's cut may cut both ways
A surprise move on interest rates leads to euphoria
on Wall Street, but will the celebration be short-
lived?
By Andrew Marks
http://moneydaily.com
Before you let Fed's unexpected rate cut and the
market's reaction to it get you feeling too happy,
remember the old saying: there are two sides
to every story.
While Wall Street, and Main Street, have ample reason
to applaud the Fed's shocker, there are flip-side
implications that will warm the heart of
the coldest bear. Today, Money Daily lays out the
good news and the
bad news.
Coming just 2-1/2 weeks after its last move, the
Fed's surprise announcement that it was cutting both
the federal funds rate and the discount rate by a
quarter of a percentage point cheered investors to
the point of euphoria on Thursday afternoon. (The
federal funds rate now stands at 5%; the discount
rate, which is the rate the Fed charges on
emergency loans to commercial banks, is now at
4.75%.)
Prior to the news, stocks were making solid gains,
with the Dow industrials up about 95 points. But
minutes after the announcement, the blue chips had
rocketed to a 370 advance. The Dow finished the day
at 8299.36, up 330.58 -- the third-largest one-day
point gain in history -- or 4.1%. The Dow is now 4.9%
higher than where it began the year, but more than
1,000 points, or 11.1%, below its July 17 high.
The S&P 500 rose 41.97, or 4.2%, to 1,047.50, while
the Nasdaq composite rose 70.04 points, or 4.6%, to
1,611.01.
Many analysts predict that stocks won't be able to
sustain the rally on Friday, however.
"There's a good chance we could give back half of
today's gains tomorrow, once investors have a little
time to think about the negative side to this news,"
says Hugh Johnson, First Albany's chief investment
strategist.
Clearly, the Fed's surprise cut is not a cut-and-
dried case of good news. Before we get to the
negative implications of this story, let's take a
look at the positive affects:
* A psychological boost to the stock market. We found
no one who believes that the Fed's second rate cut
within a month will translate into a sustainable
rally for stocks, but as Money Daily noted last
month, the action sends a strong signal. "This move,
especially as it comes between scheduled meetings,
tells the world that the Fed is as concerned
about the global financial crises as everyone else
and won't sit idly by while things deteriorate,"
Johnson says.
* It counteracts deflationary forces. It's not going
to stop the domestic economy from slowing, but lower
rates will help stave off the threat of a
recession. The Fed cited growing caution among
lending institutions as part of the reason for its
action, and this cut should keep banks lending.
The cut will also be another small boost to the
economies of the Asian and emerging market countries
that have been devastated by the flight of
capital out of their markets, by reducing the
attractiveness of parking money in the U.S. bond
market.
* A boost to the consumer. House hunters can expect
mortgage rates to drop. Brian O'Connor of Bank Rate
Monitor notes that the average rate on a 30-year
fixed rate mortgage has actually climbed from 6.7%
before the Fed's Sept. 29 cut to 6.9% now.
"Many banks panicked due to the fluctuations in the
currency markets in the last two weeks," he says.
"This cut should send rates back to the 6.5
level that they reached in the week following the
first cut."
The prime rate banks charge their best customers
should also come down from its current 8.25% average.
In fact, Bank One Corp. (NYSE: ONE) already said it
was cutting its prime lending rate to 8%. That
means credit card, personal loans, car loans,
adjustable rate mortgage interest rates should be
coming down, too.
(As always, you can find the latest mortgage rate
information in our Best Rates center at
http://pathfinder.com/money/rates.)
So much for the good side. The negative implications
of the Fed's move can be boiled down to just one
point, and William Hummer, chief economist and market
strategist at Wayne Hummer, summarizes it
neatly:
"The Fed is unique in their access to information on
the state of world liquidity and credit. If they felt
that the dimensions of the problems the world is
facing are so great that they couldn't wait until
their November meeting, then things are even worse
than most people believe."
In other words, we may not have seen the worst of
this slowdown.
"Between currency devaluations, derivative hedged
positions, and bank and brokerage exposure to them,
there's certainly a lot of potential for
more financial shocks that we can't see coming,"
Johnson says. "And frankly, I think the Fed's move
implies that these are very real threats."
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