On December 11 the Fed's policymaking Federal Open Market Committee decided to lower the key interest rate by 0.25% to 4.25%. The Federal Reserve cut its key federal funds interest rate for the third time since September. The rate cut in September was the first since 2003. Before that, there were a series of meetings when the interest rate was raised 17 times, after this the committee did not change the interest rate for nine consecutive meetings.
The interest rate cut was expected. Some market players even predicted a 0.5% cut to 4%. Under these conditions, the Federal Reserve comments were in the spotlight yesterday. The general tone of the committee's statements disappointed investors. "Economic growth is slowing ", these were the words at the beginning of the FOMC's written statement. Unlike the previous statement that noted only a supposed possible economic slowdown, yesterday's report stated this as a fact. And in addition to the US housing crisis, other negative factors included "some softening in business and consumer spending".
The committee members pointed to slightly slowing core inflation, and as in the previous statement, mentioned rising commodity prices, such as crude oil, which have been fueling additional risks of higher inflation. The statement also said that "recent developments, including the deterioration in financial market conditions, have increased uncertainty surrounding economic growth outlook and inflation". An emphasis on inflation in this context might indicate the committee's concerns about the impact of a sharp interest rate cut (by 1% since September) on price stability. In the conclusion, the statement traditionally says that the Committee will continue to assess the effects of financial and other developments on economic prospects, and will act as needed to foster price stability and sustainable economic growth.
The market fell right after the release of the Fed's statement. Key US indices lost over 2.5%. We believe that this reaction was caused by the FOMC's rather pessimistic view of the US economy moving forward. In fact, the committee members admitted that the economy is going through a difficult period, and that they preferred not to take radical measures, such as a half percent cut, under these conditions. This shattered the confidence of the market that the Fed Reserve is ready to exert every effort in order to ensure stability in financial markets and keep economic growth on track.
Based on the tone of the statement, the committee will need very serious reasons to extend the interest rate cut cycle at its next meeting. Federal Reserve officials believe that the rate cuts that were already made will be enough to help the economy withstand negative trends, and to continue growing at a moderate pace. In the short term, this decision will put negative pressure on global capital markets. We may assume that the Fed did not provide the expected support to the markets. It neither cut the rate by an aggressive 0.5%, nor did it give any intimation about its intentions to keep stability, by all means, in the financial markets. At the end of the day, the Russian market can only hope for support from domestic and corporate news.
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