Federal Open Market Committee Cuts Rates by 75 Basis Points

These various views were reflected in the dissenting votes cast by two regional bank presidents, Federal Reserve Bank of Dallas President Fisher and Reserve Bank of Philadelphia President Plosser. The important point here, though, is that while these two Federal Open Market Committee members dissented, they were not opposed to taking some action, they just wanted less-aggressive action. Assuming that they would have preferred perhaps only a 50-basis-point cut, while some FOMC members likely favored a 100-point cut, we think that the committee split the difference and settled on a 75-point cut.

We should avoid the pitfalls of losing the forest for the trees. What the markets are reacting positively to today is the fact that the Fed has responded very aggressively to the escalation of downside risks to the economy and the crisis in the financial markets over the past six months. The federal funds rate has been lowered by 300 basis points since early August 2007, while the discount rate has been chopped by an even deeper 375 basis points. In addition, the Fed has rolled out the heavy artillery on the liquidity front, with an additional $330 billion in liquidity available to the markets through the TAF auctions, the new term open-market repurchase facility leveraged with a broader range of collateral, and the special line of credit for the takeover of Bear Stearns by JPMorgan Chase.

Finally, the discount window has been opened to primary dealers in U.S. Treasury securities, which not only provides additional liquidity to the markets beyond the $330 billion already announced, but also dramatically lowers the cost of funds to securities dealers, to only 2.50%. So, the Federal Reserve is not only providing low-cost "oxygen" to the markets at a critical point in the business and credit cycle, it has also significantly increased the flow of this oxygen.

Even with this action, however, near-term cyclical risks to the economy remain elevated—the FOMC acknowledged this in its press statement, noting once again that downside risks remain. With this the dominant concern over the next several months, Global Insight is forecasting that the Federal Reserve will move to lower interest rates at its next two meetings by a further 75 basis points, thereby taking the funds rate down to 1.50% by the summer period.