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Fed's Hints
Of a Rate Cut
Cheer Markets
November 29, 2007
Amid mounting signs the nation's economy is softening, Federal Reserve officials are opening the door to an interest-rate cut next month, bringing cheer to the stock market, which staged its biggest two-day rally in five years.
The latest signal from the Fed came in a speech by Donald Kohn, the central bank's vice chairman and a confidant of Chairman Ben Bernanke. Mr. Kohn, speaking in New York, said recent turbulence in the credit markets has "partly reversed some of the improvement in market functioning" that was seen last month. "The degree of deterioration that's happened over the last couple of weeks is not something I personally anticipated," he said.
His remarks represented an acknowledgment by the Fed that the credit-market turbulence that started this summer remains a threat to the economy.
Partly in response, the stock market shrugged off disappointing news about housing market and reports suggesting weak consumer spending. The Dow Jones Industrial Average rose 331.01 points, or 2.6%, to 13289.45, the latest in a five-day string of 100-point-plus moves that have whipsawed investors.
Over the past two days, the blue-chip average has risen more than 540 points, or more than 4%, the biggest two-day point or percentage gain in five years. All 30 stock in the index were up. But that follows 237-point drop on Monday, which put the industrials 10% below their record of 14164.53 hit on Oct. 9, fulfilling the textbook definition of a full-fledged correction.
Yesterday, hopes for a rate cut by the Fed were particularly welcomed by investors in financial stocks. Merrill Lynch & Co. soared 8.9%; Goldman Sachs Group Inc., 6.7%; J.P. Morgan Chase & Co., 3.8%; and Bank of America Corp., 4.5%.
Tuesday's upturn was buoyed by the Abu Dhabi Investment Authority's $7.5 billion investment in Citigroup, a sign of hope for banks and other financial companies, many of which are in need of new capital in the wake of losses on soured mortgage-related investments. Citigroup's shares rose 6.5% yesterday, building on Tuesday's 1.9% rise.
At the Fed, Mr. Kohn and other officials are increasingly worried that banks, stung by losses from bets on risky mortgages, will, as he put it, "adopt a more defensive posture in granting credit, not only for house purchases, but for other uses as well."
Private-sector economists now think the economy will grow much less than than a 1% annual rate in the current quarter; Morgan Stanley economists yesterday halved their estimates and now foresee fourth-quarter growth of just 0.3%. The government today is expected to revise up substantially its estimate of third-quarter growth, but that won't help the outlook for the current quarter or next year.
The latest readings on the housing market also are bleak. The National Association of Realtors said yesterday that sales of existing homes fell again in October, and at the current sales pace there are now 10.5 months worth of single-family homes on the market, the most since July 1985. Reports from the Fed's regional banks, released yesterday, suggest that the pace of growth is slowing with indications of "relatively soft retail spending" and a "slow holiday season." They also cited "mixed" reports on manufacturing and some signs of weakness in commercial and industrial lending.
The market had been worried that the Fed's concerns about inflation would prevent it from taking any action at its next meeting, on Dec. 11. "Now the market smells a move by the Fed in two weeks," says Jim Swanson, chief investment strategist at Boston's MFS Investment Management. "That's giving the market a lift."
Others cautioned against reading too much optimism into the upturn. "The market is having a bounce after a correction," said Alan Gayle, senior investment strategist at Trusco Capital Management. "The rally could last for a few days, but it's not going to take us to a new high, since the market hasn't finished factoring in the negative news."
Derek Frey, head trader at Odom & Frey, predicted more volatility as the euphoria of the past couple of days is followed by mood swing in the other direction.
Although futures markets lately have been betting that the Fed would cut its target for short-term interest rates -- now at 4.5% -- by one-quarter percentage point on Dec. 11, Fed officials have been sending mixed messages. Several have emphasized publicly that inflation remains a worry despite the worsening outlook for economic growth, which complicates any discussion of cutting rates.
Mr. Kohn didn't say yesterday whether he thinks a rate cut is needed, but his apparent openness to a cut represents an important shift in tone by the Fed's leadership. Mr. Bernanke may provide more clues in a speech scheduled for tonight in Charlotte, N.C.
Fed officials had hoped its moves since August to lower the discount rate -- the rate at which it lends directly to banks -- and to cut benchmark interest rates by three-quarters of a percentage point would help restore normalcy to markets, boost confidence and head off a credit crunch. But the return of market turbulence underscores concerns that tighter lending standards would crimp consumer and business spending.
On the heels of reports earlier this week that consumer confidence was deteriorating, the most recent reading on the housing market wasn't encouraging. Sales of existing homes, including townhouses, condos and co-ops, fell1.2% in October to a seasonally adjusted annual rate of 4.97 million units, the Realtors group said yesterday. Sales are now running 20.7% behind last year. The decline came mainly in the Midwest and West.
The price of the median house or condominium -- the one smack in the middle of the market -- dropped to $207,800, down 5.1% from a year earlier. Prices for single-family homes are down 6.3% from October 2006.
| Inventories of homes rose 1.9% at the end of October to a 10.8 months supply. Pictured: A home for sale in Lockport, N.Y. |
The Fed's Mr. Kohn said yesterday housing continues to deteriorate at a "very, very rapid" rate and added, "I don't think we have seen the bottom of that market yet."
If the housing market bottoms out by spring, Fed officials believe consumer spending could remain resilient and allow the economy to sidestep a deeper downturn. Several Wall Street forecasters, however, are expecting declines totaling 15% before the market hits bottom, only a third of which have already occurred.
"There seems to be no silver lining in the darkening cloud overhanging the housing market," Nomura Securities chief economist David Resler said yesterday in a note to clients. "The risks that the weakness in this sector will pull the overall economy into recession are rising by the hour."
Separately, the Commerce Department said orders for durable goods -- items designed to last three or more years -- dropped 0.4% in October, the third month in a row the volatile measure has fallen.
"New orders, while showing their typical month-to-month volatility, have traced a sideways pattern in the past one to two years," said Michael Moran, an economist with Daiwa Securities. Orders for nondefense capital goods excluding aircraft, a closely watched barometer of business investment, fell 2.3% in October after a 1.2% gain in September. So far this year, these orders are running 1.7% behind last year.
--Michael S. Derby, Craig Karmin and Carolyn Cui contributed to this article.
Write to Sudeep Reddy at sudeep.reddy@wsj.com
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