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The Fed Cuts Interest Rates Again30 Apr 08The FOMC voted at its regularly scheduled meeting on April 30 to cut the target federal funds rate by 25 basis points, to 2.00%. It stated that the economy is weak, but substantial easing to date will promote moderate growth and mitigate risks. The Fed is expected to pause—albeit briefly—in its rate-cutting campaign. The Federal Open Market Committee's decision to reduce interest rates by 25 basis points was widely anticipated by the markets. In addition, the Fed stated that the substantial easing of monetary policy to date, combined with the massive direct market support activity that the Fed has put in place, should promote growth and mitigate risks to economic activity. By removing the reference "downside risks to growth remain," the Fed is signaling a possible pause in its rate-cutting campaign; it is indicating that policy has moved closer to a neutral position, but is not closing the door on further action to lower rates. While a pause may be preferred by the FOMC at this juncture—given the recent upward pressures on commodity prices and severe downward pressures on the U.S. currency—the underlying growth momentum of the economy continues to deteriorate. While the economy eked out a small 0.6% gain in the first quarter, virtually all of this growth is due to an increase in stockpiles, some of which will prove to be unintended. As a result, there is a very strong likelihood that the economy will shrink in the second quarter. Moreover, with crude oil prices moving up sharply, a substantial portion of the expected stimulus from the tax rebates will be offset by higher gasoline and diesel fuel prices—effectively, a partially offsetting tax increase. The upshot is that Global Insight does not expect the economy to gain much growth momentum in the next several quarters. After a brief snap-back in the third quarter, growth is expected to drop below potential in the fourth quarter of 2008, and then stall in the first quarter of 2009. As a result, we do not think that the Fed has written the final chapter of this interest-rate reduction cycle, and will resume rate cuts later this summer. So, after a brief pause in June, Global Insight is forecasting that the FOMC will reduce interest rates by a cumulative 50 basis points in the second half of 2008, taking the federal funds rate down to 1.50% by year-end. by Brian Bethune
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