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Letter to the editor

Interest builds: Will Fed make cut?

The markets are anticipating the first rate reduction in four years.

By HELEN HUNTLEY, Personal Finance Editor
Published September 18, 2007

Amid signs of a weakening economy, the Federal Reserve is in the financial spotlight today with investors hoping for a lowering of interest rates for the first time in four years.

Wall Street has widely anticipated the Fed's likely ratecut. If it doesn't materialize, both stocks and bonds are likely to fall in disappointment.

Because its focus has been fighting inflation, the Federal Reserve has been reluctant to cut rates. Mortgage defaults, a cash crisis in the market for mortgage-backed securities and an actual loss of U.S. jobs last month have put the question- will the Fed cut rates today? - front and center.

Monday brought more reminders of economic problems with news of a depositor run on Northern Rock PLC, Britain's fifth largest mortgage lender. As customers lined up to get their money out, the Bank of England was forced to step in, guaranteeing the safety of deposits at Northern Rock. Shares of the bank and other large British mortgage lenders plunged. In addition, Former Fed Chairman Alan Greenspan said in a television interview that the risk of recession is higher than it was at the beginning of the year.

In recent weeks, the Fed already has provided billions of dollars worth of funds, or liquidity, to U.S. banks through its lending power. The issue now is whether to lower the federal funds rate, the interest rate at which banks lend each other money overnight. The "fed funds" rate currently is 5.25 percent, the result of steady increases by the Fed since it fell to a remarkable low of 1 percent four years ago.

For consumers, whether a rate cut is a good or bad idea depends on whether you are a borrower or a saver. Lower rates hurt retirees who depend on income from their CDs and money market accounts. However, they help borrowers, making loans more affordable.

Lower rates will help homeowners with adjustable rate mortgages about to reset. Instead of facing a 7.5 percent rate, as they would a few months ago, a borrower might get a 6.7 percent rate on Oct. 1, said Greg McBride, an analyst for Bankrate.com in North Palm Beach. While that still will be more than the low teaser rates borrowers got initially, it may help some borrowers stay in their homes.

Most investors are expecting a quarter percent cut to 5 percent, but that's by no means a consensus view.

"A quarter point is consistent with the Fed's methodical and deliberate process and doesn't open the door to inflation like a half point cut would," said McBride.

"A quarter point buys the Fed some valuable time to assess the economy more fully before their next meeting at the end of October."

However, some think that's not enough.

"A quarter point is going to be disappointing. It's already priced in," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati.

Others think any cut at all is a bad idea. Count Tampa Bay analyst Richard Bove in that group.

"If the Fed is going to go on a path of reducing interest rates, it's going to create far more problems than it will ever solve," said Bove, who follows financial stocks for Punk Ziegel.

"It will create a crisis around the dollar. It will increase inflation," he warned.

"It will be totally counterproductive."

Helen Huntley can be reached at hhuntley@sptimes.com or 727 893-8230.

Fast facts

If the rates go down ...

Here's what to expect if the Fed lowers interest rates today.

-CD rates and money market yields will trend lower.

-Rates already have dropped on home equity credit lines and adjustable rate mortgages in anticipation of the Fed's action. If you haven't seen it reflected on your statement yet, you should soon.

-Credit card rates will trend lower, but you may not see the impact for a few months.

-Fixed mortgage rates are not tied to short-term rates. However, those rates could go lower if the economy continues to slow.

Source: Bankrate.com

[Last modified September 18, 2007, 01:57:31]