FED cuts home rates to 4.25pc but recession feared

The Federal Reserve duly reduced its Funds Target Rate by 25bp to 4.25% but disappointed both the stock and bond markets by reducing its Discount rate by only the same margin (the discount rate is the rate at which the large American Banks can borrow from the Fed directly as ‘emergency funding’).

Wall St crashed off and the European bourses arrive this morning braced for a similar reaction. The USD on the foreign exchange benefited marginally from the less than hoped for cuts.

The Fed warned that recent economic data indicated a slowdown in the US economy as a result of "the intensification of the housing correction and some softening in business and consumer spending".

It added: "Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation." These comments differ markedly from those made by Fed Chairman Bernanke after last month's interest rate cut when he sounded a relatively upbeat note on the health of the US economy.

Then it was suggested that the greater risks came from inflationary pressures due to higher energy and food prices. But with no sign of recovery in the housing market since then and the banking system still not functioning under normal conditions, analysts believe the Fed has been preparing for a sharp downturn with more interest rate cuts expected and as such were dismayed that the Fed did not move more aggressively at yesterday's meeting.

One member of the Reserve Board argued for a full 50bp cut but was out-voted by the other 9 members held firm and the lesser cut was voted through.

One interesting development that has been reported this morning is the proposal being muted at the Fed to move away from operating a discount window to provide liquidity to the market and move towards an auction based system.

A discount window is where the Fed says, here is the price that we want to lend at, who wants it? An auction, would be where the Fed says, we want to lend this much, how much do you want to pay for it.

Basically it is a way of guaranteeing a quantity amount of liquidity injection. At the moment the discount window is being very underutilised. So yes, this is a fairly important innovation IF it is implemented……..

Away from the US, we saw better than expected UK trades (still a huge deficit and largely irrelevant to the market) and a weaker than expected German ZEW report which is much more worrying for the European outlook.

Little reaction in the forex markets on these pieces of data and as such the December doldrums do seem to be taking a firm grip on exchange rates. UK unemployment and wage data today at 9.30am is the first chance for some short term action and the perennially appalling US Trade data at 1.30pm is always good for currency gyrations – the market is expecting a shortfall on about $ 57.3 billion with import prices unchanged at +1.8%.

Of the other economies, the Norges Bank are today expected to RAISE Nowegian interest rates by 25bp to 5.25% which is the level that the Central Bank predicted would be the peak for the next 12 months. Recent inflation data however suggests that the tightening cycle is not yet over and that further increases could be necessary should inflationary pressures persist.

The contents of this blog are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The Wise Money Blog cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.