Fed Funds Rate Cut to 4.75%, Discount Rate at 5.25%

After much speculation in the financial press and on Wall Street the Federal Reserve cut the Federal Funds rate to 4.75%. The Fed also lowered the discount rate to 5.25% keeping the spread between the FF rate and the discount rate at 50 bps. Fed Funds futures projected a 42% chance of a 25 bp cut and a 58% chance of a 50bp cut, though most economists predicted a 25 bp cut. In what is sure to be a very controversial move the Fed pursued a drastic policy action that may look to many as if it is seeking to "bail out Wall Street." Concerns about the strength of the economy will also be heightened as the Fed took a dramatic step today to ease in the face of a prolonged credit crisis and housing downturn. The broad market indices were up this morning on positive earnings from Best Buy and Lehman and should finish strong on the Fed's decision. You should also look for the USD to weaken further against most major currencies on recession concerns.
Here is the text from today's Federal Reserve Statement:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4-3/4%.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee's last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric Rosengren; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 5-1/4%. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, St. Louis, Minneapolis, Kansas City and San Francisco."

There are dramatic changes in the release compared to August 7th's Federal Reserve Statement:

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.

Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.

Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.

The Fed statement changed dramatically in the 6 weeks since the last release. Gone is the language about inflation moderation being "convincingly demonstrated" and gone is the emphasis on inflation as the "predominant policy concern." The Fed is clearly at the beginning of an easing cycle, though they emphasized the need to monitor incoming information and tried their best to warn investors that they are taking a balanced view on the prospects for inflation and economic growth.

I was personally quite surprised by the unanimous vote. The previous four Federal Open Market Committee meetings yielded unanimous votes to hold rates. The last time the FOMC failed to produce a unanimous vote was back on December 12, 2006 when Jeffrey Lacker advocated a 25 bps increase in the FF rate. That vote was one of a series of 4 straight votes that Lacker broke from the group in seeking to raise rates. But in light of the credit market conditions and uncertainty about the economy it definitely surprised me that between Thomas Hoenig and William Poole we didn't get a single vote for a 25 bps reduction in rates today. I expect a deluge of articles in coming days about moral hazard concerns and the perception that Bernanke is yielding to pressure from Wall Street and incumbent politicians who are hoping for a strong economy going into an election year.