Instant Insight: Federal Reserve Cuts Fed Funds and Discount Rate by 50bp, Sending EUR/USD to Record Highs

The Federal Reserve delivers a double whammy. For the first time in over a year, the Fed cut the Federal Funds rate by 50bp to 4.75 percent while at the same time reducing the discount rate by 50bp to 5.25 percent. This follows an earlier discount rate cut of 50bp in August and represents a very aggressive step by the Federal Reserve to calm the credit markets. They are not going to let inflation risks hold them back from throwing everything they have at the market. This will go a long way to boost confidence because it indicates that the Fed is being proactive which may actually be enough to prevent a recession from happening. However for some skeptics, they will see this as a sign that the Fed thinks the problems in theUS economy have gotten so severe that a big step is warranted.




As for future interest rate cuts, they did not commit to anything. The interest rate curve is actually now pricing in 4.25 percent rates by the end of the year. This means the Fed will need to deliver another 50bp of easing before Christmas.



With the odds for a 25 or 50bp rate cut essentially fifty-fifty, no move by the Federal Reserve today could have satisfied everyone. Their choice was particularly difficult this time around because they needed to walk a fine line between taking the necessary steps to make sure that growth does not slow materially while at the same time ensuring that inflation does not get out of hand. Oil prices climbed to another record high today and even though the August producer price figures showed softer inflation pressures, inflation is should have picked up again in September. As a self professed inflation fighter, Bernanke has probably given into political and market pressure.



The dollar fell significantly after the release, sending the EUR/USD to a record high of 1.3969. The stock market rallied over 100 points, taking carry trades higher in the process. Expect further dollar weakness in the days to come and expect further strength in the stock market and carry trades.





Comparing the FOMC statements

**New Language Highlighted



September 18, 2007



The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4-3/4 percent.



Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.



Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.



Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.



August 17, 2007 (Press Release after Discount Rate Cut)



Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.



August 7, 2007



The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.



Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a

robust global economy.



Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.