Fed Expected to Drop Interest Rates

Drop in the discount rate… federal funds rate could be next…

With recent turmoil in the financial markets, on August 17, the Federal Reserve cut its discount rate by half a percentage point to 5.75%. This is the rate the Fed charges qualified lenders for temporary loans. Although largely symbolic, one economist suggested that the cut has more significance than most people realize. David Wyss, chief economist with Standard & Poor’s, said the cut could help convince banks it is okay to keep lending to companies or consumers that are actually creditworthy. “This is an important move… The Fed is telling banks that the discount window is open,” Wyss said.

Although the Central Bank did not change its more closely watched federal funds rate that affects credit cards, home equity lines of credit, car loans and other consumer loan rates, many economists surveyed by MarketWatch believe the Fed will cut the fed funds rate at or before its Sept. 18 meeting. The futures market also expects dramatic cuts in the fed funds rate, with the target falling to 4.50% by year end from 5.25% at it’s current level.

“If they don’t ease, you’re going to disappoint the markets,” said James O’Sullivan, an economist for UBS. An ease would help the housing market to some extent, and would inspire more confidence in the market. Some analysts expect a quarter point cut in September followed by another one in late October bringing the rate down to 4.75%. This could drop credit card APR’s significantly over the next few months.

In another statement, the central bank indicated that “financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward.” The Fed added that “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” and that the Fed was prepared to take more action if necessary. According to federal funds futures listed on the Chicago Board of Trade, investors are betting that it is all but certain the Fed will cut the federal funds rate by at least a quarter of a percentage point.

We’ll keep you updated…