Federal Reserve policy makers treated investors to a Halloween interest-rate cut that sent stock prices soaring.
The move – the second rate cut since the subprime-lending debacle unleashed chaos and outsize losses in both stock and bond markets during the summer – brought key lending rates down to 4.5 percent and boosted the Dow Jones industrial average 137.54 points, or 1 percent, to 13,930.01.
While virtually all Fed watchers anticipated the quarter-point cut, some warned the stock market festivities might be overdone.
“They acted because they’re worried that the credit crunch is going to hurt Main Street and the economy is going to suffer,” said Bill Dwyer, who oversees the management of more than $14 billion in assets at MTB Investment Advisors in Baltimore.
But Fed policy makers find themselves walking a very narrow tightrope. If they don’t cut lending rates, the credit crunch could choke off economic growth. But if they go too far, inflation could take over in the still-resilient economy.
In an apparent effort to hammer home that dilemma to investors, the statement that accompanied that Fed’s rate cut went into a greater amount of detail than investors have seen recently.
Policy makers noted that while “strains in the financial system have eased somewhat,” there is still a short-term risk that the economy could slow.
The Fed also warned that higher energy prices could continue to boost the risk of inflation.
The bottom line: “Upside risks to inflation [now] roughly balance downside risks to growth,” the Fed pronounced.
In other words, don’t count on policy makers to provide much more help to the financial markets – especially in the wake of news that gross domestic product jumped an unexpected 3.9 percent in the third quarter.
“It’s hard to have two strong quarters of growth and keep cutting rates,” Dwyer said.
Ethan Harris, a veteran economist at Lehman Brothers, isn’t quite as upbeat about the outlook for the economy or the markets, at least in the medium term.
Tomorrow’s release of October unemployment data may be encouraging and even give stocks an extra boost.
“But the problem is that the weakness in housing will get worse before it gets better and at some point the consumer will finally react,” Harris said.
The inflation outlook is particularly worrying. In addition to a generally resilient economy – outside the troubled real estate sector and related businesses – the ever-rising energy prices coupled with the falling dollar are likely to boost inflationary pressures.
The greenback tumbled again in anticipation of the Fed rate cut, which makes it less rewarding to hold U.S. dollar-denominated assets, particularly Treasury bonds. It now requires $1.4468 to buy a single euro, up from $1.4436 late Tuesday.
Meanwhile, crude oil prices surged again, with Nymex prices closing at $94.53 a barrel.