US Fed moves on rates

The US Federal Reserve has managed to stun world markets by cutting the Federal Funds Rate by 0.25%, for the second time in three weeks. This cut, in between official committee meetings, was not expected by the markets, and as such, indicates the level of concern that Reserve Board Chairman Dr Alan Greenspan has for both the US domestic economy and the world market.

The main factor behind the sudden movement seems to be the dampened response for the previous cut in late September, which had been widely predicted in the marketplace. This second cut, bringing the Funds Rate down to 5.00%, and the discount rate to 4.75%, is widely seen as signal from the Federal Reserve that it actively seeking to manage the US economy with monetary policy.

According to the press release issued by the US Fed, the reason for the move was “Growing caution by lenders and unsettled conditions in financial markets more generally are likely to be restraining aggregate demand in the future. Against this backdrop, further easing of the stance of monetary policy was judged to be warranted to sustain economic growth in the context of contained inflation.”

The continued reduction in US rates has brought the US rate down to meet the Australian rate, also at 5.00%. This has been reflected in the continuing strong performance of the Australian Dollar, as previously the rates were skewed in favour of the $US. The Australian Dollar has also been helped by the perception that Australian financial institutions have remain relatively unscathed by either the Asian crisis or the hedge fund collapses.

Economists tend to think that US Federal Reserve will continue to reduce rates over the next six months, with the Fed rate expected to be near 4.00% by mid-1999. The recent moves by the US Fed has certainly given the Reserve Bank of Australia some room to move on its own rates, a move we would expect to see in the not-too-distant future.