The Federal Open Market Committee voted to cut the Fed Funds Rate by at least three-quarters percent today.  The benchmark rate now rests in a range of 0.000-0.250 percent.

In its press release, the FOMC identified three key economic sectors in which activity has weakened since October. The FOMC noted that:

1. The U.S. job market is deteriorating
2. Consumer spending levels are falling
3. Business investment is contracting nationwide

The Fed intends its rate cut to provide stimulate to each of these areas.

In addition, the voting members of the FOMC singled out inflation as a diminishing threat to the economy.  This is an important admission because it’s well-known that cuts to the Fed Funds Rate can spark inflation.  Rapidly falling oil prices and commodity costs, therefore, likely paved the way for today’s historic cut.

In its announcement to markets, the Fed gave The People what they wanted — a reassurance that the policy-making group would “employ all available tools” to help turnaround the economy.  Lowering the Fed Funds Rate to an all-time low is one such step; its plan to purchase mortgage-backed debt in the open market is another.

After the announcement, stock markets rallied and mortgage bonds did, too.  Rates ended the day slightly lower.

Source
Parsing the Fed Statement
The Wall Street Journal Online
December 16, 2008

http://online.wsj.com/internal/mdc/info-fedparse0812.html

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The Fed “surprised” market participants a little by voting to push the benchmark fed fund rate into a range between 0.0% to 0.25% — from its current level of 1.0%. This is the first time the Fed has ever used a “target range” to dictate short-term interest rate levels.

In their post-meeting statement policymakers said that they will “employ all available tools to promote the resumption of sustainable economic growth and price stability.”Nothing new there – central bankers have been pulling-out-all-of-the-stops in their effort to rekindle economic growth since the waning days of summer.

The Fed reiterated their intent to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets. This is stale news as well – the Fed was granted the authorization to purchase up to $500 billion of mortgage-backed securities in November. Chairman Bernanke a couple of weeks ago indicated the Fed would begin to make purchases of mortgage product before the end of the year. It now appears nothing of consequence will happen in this regard until next year.

There was a nice little knee-jerk rally in the mortgage market minutes after the rate cut was announced – but the early euphoria is slowly beginning to fade as investors realize that other than a nice little drop in overnight lending rates for banks – there is really nothing of consequence that has changed in terms of Fed policy.

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The Federal Open Market Committee adjourns from its 2-day meeting at 2:15 P.M. ET today.It’s widely expected that the Ben Bernanke-led FOMC will reduce the Fed Funds Rate by a half-percent to 0.500 percent.

Fed Funds Rate cuts are meant to stimulate the economy by lowering borrowing costs for businesses and consumers; interest rates on business credit lines and consumer credit cards are directly tied to the benchmark rate.

However, it won’t be what the Fed does today that will be as important as what the Fed says.  And the markets are listening closely.

See, this FOMC meeting was originally scheduled to last 1 day but on November 20, it was extended to 2.  Presumably, the extra day was meant to give the FOMC a chance to review its options, but now it has the markets expecting “something big”.

Wall Street wants Bernanke to outline credit-extenstion plan for banks, businesses and consumers.  It wants the Fed to bolster markets to prevent the recession from become a depression.  It wants action.  Anything short of an explicit plan should push traders into ultra-safe U.S. Treasury bonds and that should lead mortgage rates higher.

If you are floating a mortgage rate today, it may make sense to lock prior to the Federal Open Market Committee’s press release.  Expect volatility beginning around 2:00 P.M. ET today.

(Image courtesy: The Wall Street Journal)

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