At Tuesday’s FOMC meeting, the Federal Reserve surprised the market by making a larger-than-expected 50-basis-point cut in the benchmark Fed Funds rate to 4.75%. Pundits on the Street were predicting a 25-basis-point cut; hence, the large rate cut was applauded on Wall Street with the blue-chip DOW surging over 300 points or 2.3% following the announcement. Also in another move, the Fed cut the discount rate by 50 basis points to 5.25%, which was the second cut in a the last few weeks.
Clearly stock market traders are happy, but while the Fed move is good, there is also added concern that the state of the U.S. economy and the credit markets may be in fact worst off than many of us have been lead to believe. By initiating such a large rate cut, you got to think the economy could be at risk. For investors, watch to see if the rate cut could drive the economy and aid the troubled credit and housing market.
The large rate cut is clearly a move by the Fed to help the housing and credit markets, along with the economic growth. The Fed does not want any further shocks to the fragile economy.
Evidence of consumer concern was reflected in the Retail Sales reading for August, which saw sales (excluding auto) fall by 0.4% versus the estimate of a 0.2% rise and down from a revised 0.7% jump in July. The headline number was also weaker-than-expected at 0.3% compared to the expected increase of 0.5%. In my view, it is clear that consumers are fearful of the problems in the financial markets.
In addition, the RBC Cash Index of consumer confidence came in at 71.1 in September, the lowest reading since May 2006 and down significantly from 89.3 in August. Again, concerns with the housing and credit markets impacted consumers.
As we move towards the end of the third quarter, watch for the effects of the lower rates on consumers and the economy. Markets will be positive in the near term, but there remains some market concern, so be careful in your trading decisions.