Fed sounds warning on US growth

THE US Federal Reserve said the risk to economic growth in the US had "increased appreciably" after took the surprise move of cutting its primary discount rate.

The Fed moved to pump billions of dollars more cash into the financial system just before the US markets opened on Friday night. It cut the discount rate to 5.75 per cent from 6.25 per cent, declaring that "downside risks" to the economy have increased appreciably.


Markets around the world responded by rebounding strongly overnight Friday. Asian markets had already closed down across the board, but investors from Sao Paulo to London bid up shares almost immediately after the Fed announcement.

The UK's benchmark FTSE 100 surged 3.5 per cent to 6,064.20, reversing much of its losses of a day earlier. France's CAC 40 index rose 1.9 per cent to 5,363.63 and Germany's DAX index was up 1.5 per cent to 7,378.29.

In the United States, the Dow Jones industrial average surged 233.30, or 1.82 per cent, to 13,079.08.

Trading was still volatile throughout the day, with the Dow rising more than 320 points in early trading, giving up more than half those gains, and then picking up steam again. Still, the Dow was down more than 1 percent for the week.

The Standard & Poor's 500 index rose 34.67, or 2.46 per cent, to 1,445.94, and the Nasdaq composite index rose 53.96, or 2.20 per cent, to 2,505.03.

The Fed announcement that it would lower the rate on loans charged to banks stopped a global slide that had lasted more than a week amid turmoil in the credit markets. Central banks around the world have poured billions in additional liquidity into the banking system, but Friday's rate cut marked the Fed's most dramatic move.

"This move should be seen as more of a reassurance step, should interbank liquidity begin to dry up again," said ING economist Rob Carnell.

But other analysts were less certain about the move.

"The market turbulence has forced the Fed's hand here, and whilst an emergency cut might give the markets some temporary relief, some might say there is a sense of panic coming from the Fed," said Martin Slaney, head of spread betting at GFT Global Markets.

Analysts said bargain hunters helped prompt the recovery, but warned that volatility is likely to continue next week across the region.

"It is still too early to say whether this trend will continue," said Newton Rosa, an analyst at the Sul America fund in Sao Paulo. "Much will depend on the evolution of the crisis in the international markets."

The Fed said it would accept as collateral for those loans the distressed home mortgages that have led to the current crisis. It would also extend the length of repayment for the loans.

While it kept the more closely watched Federal Funds rate unchanged at 5.25 per cent, market players immediately started betting that rate would also be cut soon, probably ahead of the Fed's meeting next month, given the surprisingly stark warning issued last night.

The Fed hinted that it could move, saying it was "monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets".

Some analysts are now predicting that the US could be headed into a recession as the US housing market collapses and credit dries up. They described last night's action by Fed chairman Ben Bernanke as "baby steps".

Despite the Fed's underlying message, the intervention had the desired effect, with European stock markets soaring and Wall Street rocketing more than 300 points in the first minutes of trading, although it quickly pulled back and was 130 points higher in the morning session.

The Australian dollar, which collapsed US4c yesterday, jumped US2c and was fetching more than US79c overnight.

Futures markets pointed to a 200-point rise on Australia's S&P/ASX 200 index when trading resumes on Monday.

The index has collapsed more than 11 per cent since its record highs last month, undermined by the crisis that spread through global credit markets from the US mortgage industry.

The S&P/ASX 200 closed yesterday down 40.5 points, at 5671 points, with investors wary after Reserve Bank governor Glenn Stevens said he would have no hesitation raising interest rates on the eve of a likely November election if necessary.

The Reserve Bank board will be armed with new inflation figures when it meets on November 5, Melbourne Cup day, just a few days before November 10, the most likely date for the federal election.

Earlier this month, the Fed continued to maintain that the risk to the economy was inflation, but last night it said its cut in commercial interest rates came because the "downside risks to growth have increased appreciably".

"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward," it said.

The Fed said it had no choice but to start cutting rates "even though recent data suggested that the economy has continued to expand at a moderate pace".

The Fed's actions came despite the hundreds of billions of dollars central banks around the world have injected into the credit markets, which underpin a host of consumer transactions, from credit cards to home mortgages.

The Fed poured a further $US6 billion ($7.6 billion) into the system overnight, taking its injection since last week to $US94 billion. In Australia, the Reserve Bank has pumped at least $8 billion into the financial system.

Craig James, chief economist at Commonwealth Securities, last night described the intervention as a "smart move" designed to provide comfort to financial market investors and the public.

The Fed hoped to stop the chaos in credit markets spreading to the wider economy, he said. "It shows that we are in a time of crisis and that the Fed is concerned the problems could extend to the general economy."

But fears remain. ?Today is a very different world to the world we had a week ago,?? said Zoltan Pozsar, senior economist at Moodys Economy.com

?If the credit market does not loosen up there will be a very severe headwind to growth.??

Peter Schiff, one of the US most prominent bears on the US, said the cut in commercial rates was a ?trial balloon? that would ultimately fail.

?The Fed knows we are headed into a recession but doesn?t want to admit that.??

He said the excess liquidity the Federal Reserve pumped into the US economy over the last decade under the chairmanship of Alan Greenspan was now coming back to haunt the US.

?Greenspan made our bed and now we are going to have to lie in it,?? Schiff said.

?People keep saying this is a sound economy, but if it was so sound we wouldn?t be in this mess.??

Last night?s action from the Fed came after its liquidity injection over the last week failed to unlock the credit markets - that?s because the $US94 billion dished out to the 21 primary dealers on Wall Street was not making its way to the smaller financial institutions, which are now effectively unable to offer mortgages or offer credit to consumers.

Traders said those dealers were hanging on to the money themselves rather than on-lending, driven, in part at least, by the fact that six of those primary dealers, global investment houses Bear Stearns, Nomura, BNP Paribas, Goldman Sachs, UBS and a unit of US mortgage company Countrywide, are suffering either huge losses on the mortgages, or hedge funds, or both.

All week, veteran market traders were decrying the Fed?s efforts to pump in liquidity because the ?blood was not getting to where it was needed? and urging a cut in the discount rates so the secondary financial market could get some funds.

- with wires