Fed seen cutting rates further in multi-pronged crisis effort
WASHINGTON - The US Federal Reserve opened a meeting against a crisis backdrop Tuesday widely expected to cut interest rates sharply in a further bid to restore confidence to battered financial markets.
Just two days after the US central bank engineered a dramatic bailout of collapsing investment bank Bear Stearns, the Federal Open Market Committee began a policy meeting with global markets in turmoil.
Economists are anticipating a hefty cut in the federal funds rate -- currently at 3.0 percent -- possibly a full percentage point, as the central bank steps up its multi-pronged battle against a global credit crunch.
But some are questioning whether the Fed, under the leadership of chairman Ben Bernanke, has enough tools and power to head off a breakdown of the financial system.
Joseph LaVorgna, senior economist at Deutsche Bank, said he expects the federal funds rate to be slashed by a full 100 basis points in view of the economic turmoil.
"A deeper and longer recession seems more likely now than a brief, mild one," he said, adding rates could go as low as 1.0 percent by the end of June.
Sherry Cooper, chief economist at BMO Capital Markets, said Fed officials "will continue to act aggressively until they see sustained stabilization. Let's hope they are successful."
Yet analysts are debating how much the US central bank can do to alleviate the crisis, highlighted by the spectacular meltdown at the Wall Street investment giant Bear Stearns.
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Rushing to keep cash flowing in the financial system after the Bear Stearns debacle, the Fed cut its discount rate and made a pledge of aid to the brokerage system Sunday, moves seen as thwarting a run on the financial system.
A quarter-point cut to 3.25 percent was made to the primary credit rate, which is the cost of funds offered at the Fed's discount window for loans to institutions "in sound condition."
The Fed also said it would make liquidity available starting Monday to "primary dealers," which include brokerages that were not previously eligible for direct loans from the central bank. The Fed board also extended the maximum time of discount window loans to 90 days from 30 days.
"These actions demonstrate the extreme lengths, if there was ever any doubt, that the (Fed) Board of Governors are willing to go to" to keep markets functioning," said Bob Eisenbeis, economist at Cumberland Advisors.
Battling the economic downturn and a credit crunch in the banks, the Fed has already slashed its federal funds rate by 225 basis points from 5.25 percent last September, in an effort to ease housing and credit market stress.
"The Fed has pulled nearly every non-conventional rabbit out of the hat to provide liquidity," said Merrill Lynch economist David Rosenberg.
"The next steps may be to try and prevent a contagion, or a domino impact, and the Fed has responded to this prospect by opening the discount window to the dealer community."
But Rosenberg added that the Fed, which has pumped an estimated one trillion dollars into the banking system, has no magic bullet.
©AFP/GETTY IMAGES/File - Chip Somodevilla
"What we are learning first-hand is that the Fed can't solve all of the world's problems," he said
"The Fed cannot recapitalize the banking sector, nor can it renew investor confidence in the quality of opaque financial sector balance sheets."
Stephen Gallagher, economist at Societe Generale, argued that the Fed is correctly pumping in liquidity as it cuts rates to prevent a run on financial institutions like Bear Stearns.
"The risk of a systemic breakdown -- not too long ago seen as a remote possibility -- is now dangerously close to becoming reality," Gallagher said.
"The right medicine for the economy is to lower the debt burden of US households by allowing them to refinance existing loans into lower rates."
The Fed's task may be complicated by worries about stoking inflation
The latest Producer Price Index reading, which measures inflation pressures before they reach the consumer, showed a 0.3 percent rise in February and a 0.5 percent gain in core prices, which exclude food and energy.
"Mr. Bernanke has plenty of headaches just trying to keep the financial markets operating with a semblance of efficiency. He hardly needs to worry about inflation," said Joel Naroff of Naroff Economic Advisors.
"But he has demonstrated that he can be imaginative and aggressive in times of crises and that without a decently operating capital market and a growing economy, you really don't have a lot left. The Fed will cut today regardless of what they do, additional actions will likely be needed in the weeks to come."
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