labels: banks & institutions, stock markets - world
What is the impact of Fed rate cuts on markets? news
20 August 2007

On Friday, the US Federal Reserve cut its discount window rates by 50 bps. The discount window allows banks to borrow money from the Fed in the short-term. The rate cut is designed to ensure ample liquidity for banks. CNBC-TV18 reports on the potential impact of the rate cut.

According to analysts, the Fed cut is not in the fund rate, which is the rate at which banks borrow from each other.

During the LTCM crisis, the Fed had cut interest rates for the first time on 29 September, 1998. At that time, the market was expecting a 50 bps cut on account of future pricing. The next day the market sank by 3 per cent.

On 15 October, 1998, the Fed was forced to step in again and cut rates by 25 bps. This means that the Fed was anticipating a 50 bps cut in September but finally did so in October, analysts said.

This time around the market is expecting the Fed to cut rates by 50 bps at its meeting on September 18. Analysts feel that if the conditions in the market stabilize before that, then the Fed could cut rates in stages either on 18 September or thereafter.
However, if conditions do not stabilise in global markets, then the Fed could be forced to go in for a 50 bps cut soon, analysts said. In that scenario, they said, the Fed would be forced to go in for a 25 bps or move funds rate cut in the coming days.
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After 9/11, the Fed had cut the discount rate 11 times. In 1998, during the long-term capital management crisis, the Fed had also cut discount rates. Therefore, market participants are expecting the Fed to cut rates soon.

So, what has been the impact of all these rate cuts?

On 3 January, 2001, the Dow was up 300 points after the Fed cut discount and funds rates by 50 bps. However, after one-month it was up only 20 bps, after two months it was down 3.5 per cent, and after three months it was hitting new lows at around 9,303. On the day of the announcement there is cheer in the market.
But after one to three months, it takes its toll.

According to analysts, the 10-year yield gained 22 bps the day after the Fed eased rates and it was the single best asset that performed even better than the S&P 500. From January 3-June 4, 2001, the 10-year yield generated returns of above 9 per cent, which was around 27 per cent greater the S&P 500.

So, some of these investments could go into bonds, if yields go up.


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What is the impact of Fed rate cuts on markets?