On Tuesday the U.S. Federal Reserve Open Market Committee decided to lower its target for the federal funds rate by 75 basis points to 3.5 percent. Yet, despite the fact that the Federal Reserve has cut the fed funds rate by 175 basis points since September 2007, its Board of Governors agreed that “broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households.” Voting against the 75 bps rate cut was William Poole, who did not believe that current conditions justified policy action before the regularly scheduled meeting next week. Looking ahead, according to futures trading on the Fed Funds rate, traders are fully pricing an additional 25 bps rate cut and as much as 56 percent probability of a 50 bps rate cut when the Federal Reserve meets on January 30.
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[B]A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
Credit markets remain extremely tight as the spread between junk-rated corporate bonds and U.S. Treasuries surged more 8 bps to trade close to 616 bps.
Short term interbank lending rates remain well above government bond yields of similar maturity.
[B]STOCK MARKET: HOW IS IT DOING?[/B]
The equity bears have come out in full force with fears of a US recession accenting persistent credit market problems and scores of disappointing fourth quarter earnings reports. The benchmark, US stock indexes have been steadily falling since last week. The Dow fell as much as 6.7 percent from last Wednesday’s close, adding to a massive 18.1 percent correction from last year’s record high. A new leg in this evolving bear market seemed to begin over the Martin Luther King Jr. bank holiday. Though US markets were closed, stock benchmarks across the world were in free fall. In an attempt to avert a stock market crash on par with those in 1998 and 1987, the Fed announced a surprise 75 bp cut to the Fed Funds rate before the US markets opened on Tuesday. Despite the aggressive easing, stocks continued to lose ground.
[B]A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
The bear market seems to have taken a hold of all the major sectors of the broader equity market. Growing speculation of a looming ‘hard landing’ for the world’s largest economy has weighed on the forecast for revenue and activity in general. For most large corporations, the tangible drop in consumer spending and confidence as well as durable goods orders has clearly lowered the outlook for sales for 2008. Not even the Fed’s considerable inter-market easing could help trigger a rebound. Consumer-related sectors seemed to believe lower lending rates would do little to ultimately encourage spending.
If any market sector should have responded to the benefit of a 75 bp cut to the Fed Funds and discount rate, it would have been the financial sector. And, though the group gapped open on the open to adjust to the global sell off on Monday, the financials did rally with the additional access to liquidity and reduced cost in lending – the bread and butter for banks. What’s more, the rebound that has just begun to develop shows promise. The Bank of America’s 95 percent drop in fourth quarter earnings reported yesterday represented the last of the major financial earnings reports for the season.
[B]U.S. CONSUMER: HOW ARE THEY DOING?[/B]
Surprisingly positive University of Michigan Consumer Confidence and Initial Jobless Claims numbers temporarily boosted sentiment for the domestic consumer, but outlook clearly remains dim for all spending-linked industries. Further deterioration in housing construction measures has only compounded fears of the ongoing real estate recession, and relatively little stands in the way of a further deterioration in housing conditions. All else remaining equal, such trends will undoubtedly hurt overall consumption levels in the broader economy.
[B]A DEEPER LOOK INTO THE CHANGES THIS WEEK:[/B]
Extreme volatility in Mortgage Applications likely reflects the underlying difficulty in obtaining mortgage credit. This has coincided with further routs in all relevant housing sales indicators, and the confluence of falling credit demand on home sales underlines the difficulty in the domestic real estate sector. Housing Starts fell to fresh depths through December, and fast-slowing new construction will only sink Housing Starts further through the medium term.