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Markets Past Reactions to Fed Easing

Most investors are expecting another cut to the Fed Funds Target when the Federal Open Market Committee meets tomorrow. The debate has been whether it will be a cut of 25 or 50 bps. Here are some recent trends and facts on the Fed and the Fed Funds rate as well as a look at how the market performed the last time the Fed went into an extended phase of easing:

Current Streak
Beginning in Sept, The Fed has decreased the Fed Funds Target in 3 straight meetings plus the intermediate cut set last Tues

  • 50 bp cut - 9/18/07 rate went from 5.25 to 4.75
  • 25 bp cut - 10/31/07 rate went from 4.75 to 4.50
  • 25 bp cut - 12/11/07 rate went from 4.50 to 4.25
  • 75 bp cut - 1/22/07 rate went from 4.25 to 3.50

Recent History

  • Before the current cuts, the rate stayed at 5.25% for 10 straight FOMC meetings beginning in June 2006
  • The Last time rates were cut below 3.5% was on 9/17/2001 after the 9/11 attacks. Rates were lowered 50 bps from 3.50 to 3.00%
  • The last wave of easing began on 1/3/01 and continued through 6/25/2003 - the fed funds rate went from 6.5% to 1.00% over the 2.5 year period with two pauses along the way
    • At 1.75% from Dec 2001 through Oct. 2002
    • At 1.25% from Nov. 2002 through June 2003
  • There was a short wave of easing in 1998 that took rates from 5.50% to 4.75% with three consecutive 25 bp cuts

Markets during last loosening period (Jan 3, 2001 through June 25, 2003)

  • Dow lost 1934 points or 17.7% (from 10,946 to 9,011)
  • S&P 500 lost 372 points or 27.6% (from 1,347 to 975)
  • NASDAQ lost 1014 points or 38.8% (from 2,617 to 1,603)

Earlier periods of easing

  • Sept 1998 - Nov 1998: Rates went from 5.50% to 4.75% over 2 months, Dow up 11%
  • July 1995 - Jan 1996: Rates went from 6.00% to 5.25% over 7 months, Dow up 16%

What will Fed Chair Bernanke announce?

The Street is debating whether the Fed will cut their target rate 50 or 25 basis points in the current FOMC meeting. Current probabilities point to an ~80% chance of a 50 bp cut but are falling from earlier this month on today's good durable goods number.

General Fed Facts (from www.federalreserve.gov):

  • The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy
  • Three tools of monetary policy
    • Open Market Operations - the purchase and sale of U.S. Treasury and federal agency securities to affect the Fed Funds rate
    • Discount Rate - setting the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility--the discount window
    • Reserve Requirements - defining the amount of funds that a depository institution must hold in reserve against specified deposit liabilities
  • FOMC Structure
    • Twelve members-- 7 members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and 4 of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis
    • 8 regularly scheduled meetings per year plus additional meetings as needed