The Federal Reserve, confronted with a global stock sell-off fanned by increased fears of a recession, cut a key interest rate by three-quarters of a percentage point on Tuesday. Fighting to stave off recession in the world’s biggest economy, the decision comes after sharp stock market declines on Wall Street and around the globe.
The Fed said incoming information indicated a deepening of the US housing market slump and increased unemployment levels.
One analyst said the Fed was “obviously panicked” by the threat of recession. “Unfortunately they have no power to reverse what in my opinion is the worst post-war recession,” said Michael Metz, chief investment strategist at Oppenheimer in New York.
‘This is huge’
The Fed’s interest move came as a complete surprise, as it was taken outside its timetabled rate-setting Open Market Committee meetings.
The last two such surprise cuts were on 17 September 2001, shortly after the attacks of 11 September, and on 3 January 2001, in the wake of the dotcom bust. The last time the Fed cut rates as much as three-quarters of a percentage point was in August 1982, almost 26 years ago.
“This is huge,” said business editor Robert Peston. “And it is a big risk. If this doesn’t work, then people will say they have nothing left in their locker.” Analyst Jeremy Stretch of Rabobank, described the Fed’s move as “a sign of panic”.
“But it certainly indicates that the Federal Reserve wants to be seen as taken action over the concerns of an economic downturn,” he said.
Yet despite the Fed’s extensive cut in rates, US investment bank Merrill Lynch said at the start of this month that, in its opinion, the American economy was already in recession.
Another investment bank, Goldman Sachs, has also warned that recession is now likely.
The sharp downturn in the US economy has centred on the slump in the American housing market over the past year. Against a backdrop of higher US mortgage rates, home loan defaults and repossessions hit record levels last year, specifically in the sub-prime sector.
This industry specialises in higher risk loans to people on low incomes or those with poor credit histories. As the sub-prime mortgage sector hit crisis point, it triggered record losses at some of America’s largest banks.
It also caused the global credit squeeze, as much of this sub-prime debt was repackaged into wider debt offerings that were bought by banks and other investors around the world. As a result, global banks are now much less willing to lend to each other, or to homes and businesses, until the full extent of the sub-prime exposure is known.