Fed Funds at 5.5%, Lowest in Decade

Amid growing concern about the strength of the economic recovery, the Federal Reserve cut its apparent fed funds rate target to 5.5%, the lowest level in 10 years.

The move's timing surprised money-market participants who were focusing on recently released U.S. economic data.

The Labor Department reported Friday that nonfarm payrolls declined by 51,000 in July. In addition, key money supply measures dropped last week.

Different Expectations

Some economists had been expecting the Fed to act immediately after the unemployment statistics were released, but others expected no move until later this month after the next meeting of its policy-setting open market committee.

"I think you'd be hard pressed to find anybody who thought 11:30 Tuesday would be that magic moment," said Jan Hurley, a senior market analyst at Chase Manhattan Corp.

Ms. Hurley said Fed Chairman Alan Greenspan may have waited until now because it was difficult to build a consensus for a rate easing among the Fed governors. Others speculated that the Fed may have been reacting to economic statistics not yet released to the public.

But no one in the market doubted that an easing had taken place. "You'd have to be hit in the head with a sledgehammer to think otherwise," said Lawrence J. DiTore, a senior vice president at the brokerage firm Babcock Fulton Prebon.

Signal on Economy?

Because they translate into lower funding costs, lower rates are good news for banks. But to the extent they signal weakness in the economy, rate cuts do not bode well for the industry.

"Any money banks can save on the liability side is going to help them out," said William Downes, a vice-president at Keefe, Bruyette & Woods Inc. "But longer term, for banks to really turn on earnings, you still need some help from the economy."

The apparent cut was the first in three months for this key short-term rate. Some economists, confident that a recovery was starting, had actually predicted this summer that the next rate move would be upward. But with statistics indicating any recovery is anemic at best, expectations of a rate increase faded.

Fed Governor Edward Kelley said Tuesday that no strong sign had appeared yet of an economic recovery. He was particularly concerned that corporations had not begun to increase inventories, he said, and that high debt levels among consumers and corporations were working against a recovery.

Bonds Rise

The bond market rallied on news of the easing. The discount rate on three-month Treasury bills was 5.42% Tuesday afternoon, down from 5.51%. But the decline was less in long-term rates - the when-issued benchmark 30-year bond was yielding 8.15% Tuesday afternoon, down from 8.20%.

At 5.5%, fed funds are now targeted at the same level as the discount rate, the rate the Fed charges banks borrowing overnight directly from it.

Typically, the Fed prefers to keep the funds rate above the discount rate, traders said. But they predicted the Fed would likely wait for additional data on the economy's health before changing the discount rate.

PHOTO : Down Another Notch Source: American Banker

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