The Federal Reserve handed out a second interest rate cut on Halloween, giving markets and borrowers the treat they were expecting.
But skeptics questioned whether the quarter-point rate cut aimed at shoring up the housing market would unleash the specter of inflation on a day where gold and oil prices hit new highs.
“If they hadn’t cut interest rates, it would have been a disaster,” said Ashwani Kaul, a senior analyst with Reuters Estimates in New York.
Stock investors had priced in a cut, and the absence of one would have spooked markets in a big way, he said.
The Dow Jones industrial average rose 137.54, or 1 percent, to 13,930.01, while the Nasdaq composite index rose 42.41, or 1.5 percent, to close at 2,859.12 Wednesday.
Consumers should benefit from the Fed action via lower costs on variable-rate credit cards, auto loans and home-equity lines of credit, said Scott Anderson, a senior economist with Wells Fargo in Minneapolis.
Those consumer loan rates are tied to the prime rate that banks began immediately cutting to 7.5 percent, following the quarter-point cut in the federal funds rate to 4.5 percent.
The Fed action followed an initial reduction Sept. 18 that took the rate for what banks charge each other for overnight loans from 5.25 percent to 4.75 percent.
Former Dallas Fed President Robert McTeer said the central bank didn’t need to make a cut, given the unexpectedly robust 3.9 percent gain in third quarter real Gross Domestic Product.
Half the gain in GDP was attributed to a strong 3 percent rise in consumer spending, which rose despite a credit crunch in August that made it harder to cash in on home equity or refinance out of risky mortgages.
Central bankers are looking at where the puck is headed, not where it is, McTeer said.
“A cut might put the Fed in the right place if we start to go into a recession in a few months,” he said.
A key reason the Fed gave for cutting rates was the drag the housing slump is having on the overall economy.
Rate cuts could provide some limited support for the nation’s ailing housing sector, in particular the borrowers holding the $1 trillion in adjustable rate mortgages set to adjust higher over the next five years, Anderson said.
“We may not see as many foreclosures,” he said.
Long-term mortgage rates, however, are tied more closely to the 10-year U.S. Treasury, which could rise in yield if foreign investors, who hold close to half the outstanding federal debt, sell off.
In the looking-glass world of global finance, lower interest rates make U.S. assets less attractive to foreign buyers and put downward pressure on the U.S. dollar, Anderson said.
More dollars are then needed to buy imported goods, like oil, contributing to higher prices and reducing consumer spending power.
Gold topped $800 an ounce for the first time since 1980, while oil rose above $95 a barrel, a new record on Wednesday. Gold is a hedge against inflation.
The dollar reached an all-time low against the euro and reached its lowest levels against the Canadian dollar in five decades.
Kansas City Federal Reserve Bank President Tom Hoenig, whose territory covers Colorado, cast a rare dissenting vote against the rate cut.
Hoenig’s dissent likely signals growing concern that efforts to pump up the ailing housing market should not come at the cost of unleashing inflation, Anderson said.
The Fed may have felt pressure to avoid compounding the decline in home values with a decline in stock prices, further reducing household net worth, Kaul said.
“This rate cut was more for the financial markets, for the psychology of the markets. It was more to keep people happy,” Kaul said.
Aldo Svaldi: 303-954-1410 or asvaldi@denverpost.com
FALLOUT FROM THE FED
Automobile loans, variable-rate credit cards and home-equity lines of credit
Rates on these products are tied to bank prime rates and should come down in the coming days after the Fed’s quarter-point rate cut.
Long-term mortgage rates
More closely tied to the yield on U.S. Treasuries. If foreign investors respond to the Fed rate cuts by selling U.S. holdings, the cost of fixed mortgages could actually rise.
Bank deposits and money market funds
People who rely on these investments will likely see income reduced. But banks such as Countrywide looking for more deposits to fund mortgages are offering above-market rates.
