The Fed Moves to Ease Economic Fears

Another big interest rate cut will be cheered by Wall Street as well as Main Street.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

March 18, 2008

In reducing a benchmark short-term interest rate by three-quarters of a percentage point Tuesday, Federal Reserve Chairman Ben Bernanke is sending a two-pronged message. With financial markets expecting a full percentage point cut, he wants to stem mounting criticism that he's too beholden to Wall Street. But by cutting more than half a percentage point, he's encouraging the view that the Fed is committed to taking bold steps to stop the economy's downward spiral.

The statement by the Federal Open Market Committee (FOMC) that "downside risks remain" means that more cuts from the current benchmark rate of 2.25% are likely in coming months. We expect to see another half-point reduction in rates before midyear, despite some concerns -- including from two members of the FOMC -- that rates are coming down too far and too fast, sowing seeds for future inflation. Others worry that lower rates will make a weak dollar even weaker.

Commercial banks will follow Tuesday's Fed move by trimming their prime lending rate to 5.25% and bringing down rates on adjustable mortgages, home equity lines of credit and credit card debt.

The FOMC statement concedes that "uncertainty about the inflation outlook has increased," but it's clear that Bernanke wants to dampen a weakening economy. And he's using more weapons than interest rates. With no buyers for mortgage securities, the Fed last week began accepting them as collateral for loans to commercial and investment banks. The Fed also made a huge change in tradition as it engineered the sale of Bear Stearns last weekend, enlarging the Fed's role in how big investment banks are functioning. The latter steps are aimed at restoring confidence among participants in credit markets.

It has become clear that Bernanke sees the need to fight a war against recession on several fronts. He's leading the Fed to act on easing consumer debt, trying to thaw a freeze in most credit markets and even suggesting remedies to the rising wave of home foreclosures. Serious problems remain, and that's why we think Fed intervention is far from over.

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