Although many financial analysts had been predicting and hoping for a .75 basis point Fed interest rate cut on or before the January 30th Central Bank meeting, today’s surprise cut announcement caught Wall Street off guard and contributed to one of the more volatile days the equity markets have seen.

The announcement came before trading opened (January 22) in the US and sent investors scrambling.  After huge early losses that saw the Dow drop 465 points, investors began to buy back into the market.  The index pared virtually all its losses in the mid morning, before returning to negative territory in early afternoon trading.

The dramatic move of a huge cut prior to the Fed meeting sends a clear message that the Central Bank, along with the Bush administration, are not going to sit back and hope against a recession.  They are attempting to be proactive.  President Bush recently introduced his $145 billion tax rebate plan to help spark the economy.  Today’s rate cut shows the Fed is going to take a very aggressive position to help the still struggling housing and mortgage markets and an economy showing signs of recession.

Recent surveys indicate nearly two out of three Americans believe the economy is headed toward a recession in 2008.  Consumer spending and consumer confidence, combined with slumping retail sales show the housing and mortgage markets are spilling over into the broader economy.  Along with today’s strong move, Fed Chair Ben Bernanke indicated a great likelihood of even more cuts.  Today’s cut left the current Fed fund interest rate at 3.5%.

In spite of today’s bold cut, many US lenders had already priced in the expected drop in the Fed fund rate.  In fact, the cut actually was needed as much to reinforce market reaction to the predicted cut.  A cut of .5% would likely have had a negative impact on mortgage brokers who had already lowered rate promotions in line with expectations.  Today’s average bankrate.com 30-year fixed interest rate is 5.42%.

Mortgage brokers have been flooded of late with people look to refinance homes at record low rates.  Even people with reasonable rates prior are looking to get in at a potential rock bottom rate.  With the announcement of further Fed cuts, it is certainly possible lender rates could fall even more, but there really is not much more banks can do at this point to make mortgage borrowing more affordable.  Many mortgage bankers worked through a potential holiday Monday to tackle market demand.

Americans will likely see a stronger reaction in second mortgage and variable credit card rates with today’s Fed cut.  These markets are usually not as quick to build in future expectations.  Small percentage cuts in personal loans are not as demand driven as the higher value mortgage loans, thus credit card demand does not see nearly the growth that mortgage loans do when rates are lowered.  This also has something to do with the 15 to 30 year planned payout period for mortgages.

For many Americans struggling with record delinquency and record balances, however, a percentage point or two of reduced personal loan interest can be a great savings on monthly budgets.  Ultimately, the key with the Fed rate cuts is whether other economic factors support businesses and individuals in a way that inspires them to seek capital.  Will cheap rates entice more home buyers and business expansion, or will economic concern and recession uncertainly lead to more risk aversion?  With the US impact on world economy, many global markets are concerned that US recession could lead to a broader global crisis.

Market Recap

After watching Asian and European equities crumble over the trading holiday Monday, US markets opened with extreme panic.  The big news on Wall Street Tuesday was the Fed rate cut of .75 points to 3.5%.  The unexpected move contributed to a volatile day for the Dow and a huge 465 point drop in early trade was quickly reversed.  After paring most of the losses in the late morning, the Dow was back down by 140 points in the late afternoon with one hour of trading left.  Oil prices dropped back below $90 per barrel based largely on recession fears.  Bank of America saw a fourth quarter profit plunge, while JNJ and UnitedHealth saw expected small profits.

Neil Kokemuller
Tuesday, January 22, 2008
2:45 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University with a specialization in marketing.

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