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The Federal Reserve Cut Interest Rates 75
Basis Points
Market Comment, 1/22/2008
The Federal Reserve Cut Interest Rates 75
Basis Points
The Federal Reserve cut interest rates on
an emergency basis by 75 basis points to 3.5%, ahead of its next
scheduled meeting at the end of January. The Fed is determined to add
liquidity to the economic system and shore up investor confidence. This
is the biggest single move in the funds rate since it was raised by that
amount in 1994. The Dow Jones Industrial Average opened down nearly 400
points. The market clearly did not welcome the news which might suggest
to some that the Fed panicked. We do not believe that this is the case.
Rather, as we have noted in our previous Risk Premium commentary, a
decisive move by the Fed was necessary to bolster consumer confidence,
notwithstanding the effect on the stock market. Over the long-term, we
believe the Fed’s action will prove correct. The unprecedented nature
and timing of this cut was not, however, helped by an accompanying
statement by the Fed that it was motivated by the increasing downside
risk to growth and the broad deterioration in labor, housing and the
financial markets.
There is a growing debate whether the Fed
will cut rates at its scheduled meeting next week. Several economists
believe that the Fed will cut rates by at least 25 basis points or even
50 basis points. Based on the tone of the Fed’s comments it is easy to
see how investors could interpret the emergency action as a signal that
the economy is already in a recession. Apparently, Ben Bernanke took a
firm hand with the committee since the vote was not unanimous. We
continue to feel that the economy is in the formative stages of a
recession and that equilibrium will not be established until the cycle
has run its course. The Dow Jones Industrials Average P/E multiple is
approximately 14.6x and earnings’ multiples may have to adjust downward
to at least 10x to 12x or lower before bottoming out.
Finally, the likelihood of a federal
rescue plan is still questionable, although the White House was quick to
note that a change in fiscal policy will also be needed to bolster the
economy. In short, there is considerable uncertainty across all market
sectors and more time will be needed to assess the magnitude of this
economic slump and the extent of this bear market.
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