A day after the Federal Reserve’s first cut in the federal funds rate in four years, a relatively positive marketplace response was tempered by some wariness.
The Dow Jones industrial average rose 76.17 points to 13,815.56 on Wednesday, confirming that Tuesday’s gain of nearly 336 points wasn’t a knee-jerk reaction.
The Fed cut, aimed at forestalling a recession driven by the subprime- mortgage crisis, dropped the benchmark funds rate a half-point to 4.75 percent. That rate is what banks charge one another for overnight loans.
But the benefit of the rate cut may be diluted if foreign investors continue to sell off U.S. Treasury notes and push up long-term interest rates.
“The recent drop in foreign holdings of U.S. Treasurys at the Fed is troubling, with China having been a net seller in each of the past three months,” Liz Ann Sonders, chief investment strategist at Charles Schwab, said in a report.
When the Fed aggressively lifted short-term interest rates between 2004 and 2006, foreigners bought up U.S. Treasurys, keeping a cap on long-term interest rates.
As the Fed starts cutting, the opposite pattern appears to be taking shape, Sonders said. Lower demand for Treasurys will force their yields higher, making certain forms of credit such as 30-year mortgages more expensive.
The yield on the 10-year Treasury note rose to 4.52 percent Wednesday, up from 4.32 percent rate early last week.
But the Fed shouldn’t have to worry as much as it has in the past about inflation.
“With weak economic activity expected for the next several quarters, core inflation should retreat further even if the Federal Open Market Committee’s rate cut gives a boost to economic growth,” predicts Steven Wood, an economist with Insight Economics in Danville, Calif.
On Wednesday, the Bureau of Labor Statistics reported that the Consumer Price Index fell by 0.1 percent in August, driven primarily by a 3.2 percent drop in energy prices.
Consumer inflation is up 1.9 percent for the past year.
A report on housing starts Wednesday showed the slump in residential real estate continues to worsen.
New housing starts fell to an annualized pace of 1.33 million in August, the lowest level since June 1995. Housing starts are down 41.9 percent from the peak they hit in January 2006.
A slowing economy is behind arguments that more Fed rate cuts are coming, despite pronouncements otherwise.
“The Fed was quick to point out that this ease does not guarantee any additional ease,” said Robert Bush, a fixed-income analyst with Eric Forecasting in Englewood.
But he said those cautious Fed comments were likely “window dressing” designed to cover future rate cuts that it will have to make down the road.
Some analysts, however, don’t consider inflation tamed.
“If you look at how people are spending their money and what is going up, inflation is much worse than what is shown in government reports,” said James Turk, chairman of GoldMoney, a website selling gold and silver bullion.
Rate cuts and a sluggish U.S. economy make the U.S. dollar less attractive. And a weaker dollar in turn makes commodities such as oil and gold more expensive, not to mention the cheap Chinese imports that American consumers have grown accustomed to.
Staff writer Aldo Svaldi can be reached at 303-954-1410 or asvaldi@denverpost.com.
