Fed Expected To Ease Further Despite Global Rate Cut

With three weeks to go until its next scheduled policy meeting, the Federal Reserve - in a coordinated effort with other central banks around the globe - cut its benchmark lending rate today by 50 basis points. This unprecedented globe-spanning rate cut represents yet another step in the lengths policy officials have to go in order to correct an ongoing financial crisis and forestall the first global recession in recent memory.

The Economy And The Credit Market

With three weeks to go until its next scheduled policy meeting, the Federal Reserve - in a coordinated effort with other central banks around the globe - cut its benchmark lending rate today by 50 basis points. This unprecedented globe-spanning rate cut represents yet another step in the lengths policy officials have to go in order to correct an ongoing financial crisis and forestall the first global recession in recent memory. However, despite the approval of the massive $700 billion US bailout plan last week and the additional rate cut from the policy board this morning, sentiment in the credit and financial markets has yet to improve. In fact, the pessimism that developed while conditions deteriorated at an accelerated pace have kept rate expectations to the dovish side. Fed Fund futures are still pricing in a 90 percent probability that policy officials will cut rates another 25 basis points to 1.25 percent on October 29th.

A Closer Look At Financial And Consumer Conditions

The health of the financial and credit markets is far more than just a US concern now. European banks have required government bail outs, liquidity in the global credit market has essentially dried up, and lender and investor confidence has plunged to its lowest levels since the Great Depression. While sentiment has deteriorated for some time now, recent conditions have reflected nothing short of a market-wide panic. Risk aversion is so prevalent that nothing short of Treasuries is considered safe enough. This is clear in the chart above where the yield on three month Libor and Treasuries assets diverges.

With the financial crisis intensifying, the market's focus is shifting even further away from the longer-term impact of the turmoil and towards the pressing need for liquidity. And, while immediate solvency should be more important than the environment six months down the line, the health of the economy shouldn't be ignored. There is little doubt that the US is facing a recession through the second half of 2008 (though Fed members have held their outlook to just a slowdown) with the availability of credit and consumer spending tipping the scales. The next concern: a global recession.

The Financial And Capital Markets

The financial and capital markets have fallen into disorder recently; and unlike the market crashes of past decades, this crisis is more deeply rooted and therefore has steadily worsened with time. Looking back to the last significant market collapse in 1987, the markets dropped sharply and quickly stabilized after regulator intervention. This time around though, the problem isn't just set in investor sentiment. Instead, there are true fundamental drivers behind the consistent decline in the value of assets and desperate search for liquidity. Built up leverage through derivatives and fading asset values have left financial participants little option but to liquidate their massive positions or face bankruptcy. What's more, deregulation and the easier flow of investment capital over international boarders has facilitated the spread of the crisis. Now, the only effective methods to curing the turmoil will have to be global ones.

A Closer Look At Market Conditions

Capital markets are plunging as fears over the state of credit liquidity multiply. Today, the benchmark Dow 30 dropped to its lowest level in five years intraday; but the unexpected 50bps rate cut from the Fed has offered at least a temporary buffer to ongoing losses. A genuine turn in the market will come with a rebound in confidence which is wholly dependent on credit conditions. Commodities prices on the other hand have tumbled 35%, reflecting growth - rather than credit - concerns.

Risk appetite is no longer just the burden of asset values, it is the foundation for a freeze in basic lending - the lifeblood of the global economy. At the banking level, fears that another major financial institution will go under mean few are willing to take the chance with counter-party risk. This is evident in the risk premium behind credit default swaps (though even those are skewed due to credit crisis). For investors, there are few places to keep funds safe. Their panic can be seen in a record 55% VIX reading.

DailyFX

Disclaimer

Investment in the currency exchange is highly speculative and should only be done with risk capital. Prices rise and fall and past performance is no assurance of future performance. This website is an information site only. Accordingly we make no warranties or guarantees in respect of the content. The publications herein do not take into account the investment objectives, financial situation or particular needs of any particular person. Investors should obtain individual financial advice based on their own particular circumstances before making an investment decision on the basis of the recommendations in this website. While we try to ensure that all of the information provided on this website is kept up-to-date and accurate we accept no responsibility for any use made of the information provided. All intellectual property rights are the property of Daily FX. Daily FX and its affiliates, will not be held responsible for the reliability or accuracy of the information available on this site. The content herein is provided in good faith and believed to be accurate, however, there are no explicit or implicit warranties of accuracy or timeliness made by Daily FX or its affiliates. The reader agrees not to hold Daily FX or any of its affiliates liable for decisions that are based on information from this website. Daily FX highly recommends that before making a decision, the reader collects several opinions related to the decision and verifies facts from at least several independent sources.