For homeowners, it could lead to lower mortgage rates in the months to come. For investors, it could help stabilize and bolster volatile share prices. For Wall Street financiers and for companies across America, it could eventually make borrowing easier and cheaper.
“This is a bold move,” said James T. Swanson, chief investment strategist at MFS Investment Management, a mutual fund company in Boston. “It’s going to alleviate concerns that the credit market will kill the economy.”
But while the news was welcomed by many, the reaction was not universally upbeat.
Economists and market specialists cautioned that the cut would take time to work through the system. It could stoke inflation and send the dollar tumbling, especially if it is followed by another cut in the coming months. And the move may do little to help families who are confronted with rising mortgage payments, falling home prices and a weaker job market. Furthermore, unexpected problems could yet emerge in the complex investments that were popular with banks and hedge funds.
The rate cut, to 4.75 percent, was twice as large as most investors had expected, and it showed in the market’s reaction. The Standard & Poor’s 500-stock index rose 2.92 percent, to 1,519.78, and the Dow Jones industrial average rose 335.97 points, or 2.51 percent, to 13,739.39. It was the biggest single-day gain for both indexes since early 2003.
Wall Street’s enthusiasm spilled into Asia this morning. Japan’s benchmark Nikkei 225 stock index soared 579.74 points, or 3.67 percent, to 16,381.54 points on the Tokyo Stock Exchange at the market’s close.
In Hong Kong, the blue-chip Hang Seng Index jumped 733.05 points, or 2.98 percent, to 25,309.9 in early trading after rising as much as 3.72 percent minutes after the market opened.
Many commercial banks followed the Fed and cut the prime rate they charge their best customers for loans. In the commodity markets, gold and oil prices both surged yesterday afternoon. The dollar fell to a new low against the euro.
Investors in the futures market are now betting that the Fed will cut rates at least once more this year, to 4.5 percent, at the meeting in late October. But the central bank was more guarded. Noting that “some inflation risks remain,” the Fed said that its actions would have to balance concerns about slowing growth against the threat of inflation.
For the broader economy, changes in the Fed’s target short-term interest rate, which banks charge one another, usually takes several months to a year to have a noticeable impact.
The average rate for a 30-year fixed mortgage stood at 6.31 percent last week, down from its high for the year of 6.74 percent in June, Freddie Mac said. The rate could fall further if the Fed’s move and statement encourage investors to buy more mortgage-backed securities, which are used to finance loans.
There is some indication that investors may have a bigger appetite as a result of the Fed’s actions. The premium that investors demand to hold bonds issued by corporations and agencies like Fannie Mae, the big buyer of home loans, over Treasuries narrowed noticeably yesterday.
“The key is going to be whether this cut sparks risk appetite,” said Binky Chadha, chief United States equity strategist at Deutsche Bank in New York. “And the last two hours suggests that it is clearly doing that.”
Since the credit squeeze began in late July, some on Wall Street have been clamoring for the Fed to cut interest rates and ease the flow of money in the financial system. Perhaps the most colorful display of that sentiment came in early August when Jim Cramer, the CNBC talk-show host and a former hedge fund manager, railed against the Fed and said the central bank’s chairman, Ben S. Bernanke, “has no idea how bad it is out there.”
Mr. Bernanke and the Fed, for their part, stayed above the fray, in an effort that many bank watchers say was intended to avoid the perception that policy makers would bail out investors who made bad bets. The Fed then cut the discount rate it charged to lend money directly to banks, and it stepped up its lending activities to ensure that the Fed funds rate remained at or below the previous target of 5.25 percent.
Those measures, coupled with a growing belief that the Fed was poised to cut interest rates, injected some optimism into the market in recent weeks. Before yesterday’s announcement, the S.& P. 500 index, for instance, was up nearly 5 percent from Aug. 15. That essentially put the index back to where it was after policy makers decided in early August to keep rates unchanged.
In the credit markets, the adjustment has been somewhat slower. The commercial paper market for short-term debt remains tight, though borrowing costs for companies and banks that use those loans have been trending lower. The premium that investors demand to hold corporate and high-yield bonds has narrowed, though it remains far wider than it was early this year.
In the mergers and acquisition world, investment banks have been able to bring some pending deals to market, but they have had to offer investors higher returns and other incentives. Bankers are still sitting on more than $300 billion in leveraged loans that need to be sold to investors.
Market specialists say that yesterday’s rate cut may do little to address the bigger problems in the credit markets. Lower rates are helpful, these people say, but they may not make banks and investors more willing to lower significantly the premium on mortgages to people with less than stellar credit or those who are borrowing a large amount with little money down. The concern is that such investments could suffer losses if the economy continues to weaken and if house prices fall further.
The crisis in the credit market has already driven many mortgage lenders out of business or away from certain kinds of loans like jumbo mortgages for amounts more than $417,000. This cut in interest rates is not expected to solve the broader problems in the housing market.
“It certainly is going to help, but part of these problems we are facing are intractable,” said James L. Melcher, a partner at Balestra Capital, a hedge fund in New York that believes the housing problems will intensify.
Mr. Melcher and other market specialists are also concerned that too much easing by the Fed could spur inflation. Another source of inflation would come from a falling dollar, which would make imports more expensive while making exports cheaper.
One euro now buys $1.3984, up from $1.3868 on Monday evening.
Gold, which rises in value during periods of high inflation and when the dollar is weak, rose 1.6 percent, to $728.60 a troy ounce, and crude oil prices jumped 2.25 percent, to $82.38 a barrel. Both commodities set records.
Market specialists said the size of the Fed’s rate cut and its nod to inflation suggested that policy makers were trying to keep investors’ expectations in check regarding future rate cuts.
Peter E. Kretzmer, a senior economist with Bank of America, said policy makers were trying to draw attention away from the central bank for a little while.
“They said we’re going to be a little bold and remove at least one source of uncertainty,” Mr. Kretzmer said. “And that is the source that says, ‘What is the Fed thinking, and when will they move again?’ Maybe they can take the market’s mind off the Fed for a little while.”
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