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Calls for 1-point rate reduction grow louder
Bear Stearns shocker triggers forecasts for whopper cut to 2%
By Laura Mandaro, MarketWatch
Last Update: 7:52 PM ET Mar 14, 2008
SAN FRANCISCO (MarketWatch) -- Expectations that Federal Reserve next week will cut rates by a full percentage point, to 2%, gained traction among economists and traders Friday after a bailout of Bear Stearns Cos. revealed more fault lines in the U.S. financial system.
Citigroup economists said they anticipate Fed policy-makers will lower the federal funds rate by a point to 2% next week from the current 3%, "and more cannot be ruled out."
"Aggressive action is needed to stabilize the financial setting," according to economists in a research report led by Citi's Robert DiClemente. The decision by the New York Fed and JPMorgan Chase & Co. JPM to provide financing to Bear Stearns BSC "underscores the current fragility of the system."
On Friday, Bear Stearns said that it was forced to draw on short-term financing from the Fed, through J.P. Morgan, after its liquidity "deteriorated significantly" during the past 24 hours. The news sank stocks and pushed investors further into bonds and commodities, which are increasingly seen as a safe haven to market disruptions. See full story.
Credit-market troubles and slowing growth have the potential to unleash the worst U.S. recession in more than 25 years, the Citigroup economists said.
Also feeding into expectations of deeper rate cuts, the Labor Department announced that consumer inflation in February was flat from January, or less than economists were anticipating, though prices gained 4% from the year-ago month. See full story.
Economists in general have been more cautious on the likelihood of rate cuts than the futures market, though they have raised their expectations recently.
Those surveyed by MarketWatch now anticipate the Fed will cut rates by 75 basis points next week, to 2.25%, deeper than the 50-basis point cut they anticipated a week ago.
Since it started cutting rates in September during the first wave of global credit crunch, the central bank has slashed interest rates to 3% from 5.25%. As problems in the subprime-mortgage market spread to other parts of the banking system, creating big write-downs on Wall Street and freezing whole pockets of the credit market, it jumped in with bigger, surprise cuts this year.
Led by Chairman Ben Bernanke, the Fed has used other tools to try to ease the ongoing credit crunch, such as making itself available for $400 billion in bank and broker loans.
The Fed's apparent willingness to loosen the money supply, combined with nearly daily blowups in the financial system, has pushed up the odds on futures that price in the likelihood of rate changes. Traders in this market are now anticipating a 100-basis point cut in March.
The April contract Friday jumped to 97.88, which translates to 100% odds the Fed will lower interest rates by 75 basis points, and more than 50% odds of an additional 25 basis points -- which would bring short-term interest rates to 2%.
On Thursday, federal funds futures priced in 88% odds for just a 75 basis-point cut. Some 42,557 April futures contracts, which market participants use as a snapshot of expectations on the March meeting, traded hands on the Chicago Board of Trade.
One basis point is 1/100th of a percent.
Deutsche Bank economist Joseph LaVorgna said Friday that his bank now believes the Fed will cut rates by 75 basis points on Tuesday, "and the odds of a 100 basis cut are growing."
"There has been no letup in financial market deterioration," he wrote in a research report. "Whether the Fed opts for an unprecedented 100 basis-point move will depend largely on financial-market conditions, namely whether the market further raises the probability of systemic solvency issues."
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