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Another Move, but with Less Surprise

At its scheduled meeting yesterday, the Federal Open Market Committee (FOMC) lowered its target for the federal funds rate 50 basis points to 3 percent. In the post-meeting statement the FOMC noted that, "Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of information of the housing contraction as well as some softening in labor markets."

In its assessment of risks the FOMC indicated that the "policy action, combined with those taken earlier, should help to promote moderate growth over time and mitigate the risks to economic activity. However, downside risks to growth remain."

Yesterday's decision followed just nine days after the January 21 decision to lower the target 75 basis points to 3.5 percent. That move, taken at an unscheduled meeting, surprised participants in fed funds futures and options markets. Until that decision, traders had not seriously entertained the prospect that the fed funds rate would be as low as 3 percent after yesterday's meeting. After the new target was announced, market participants began to place some probability that the outcome could go as low as 2.5 percent.

January Meeting Outcomes

Over the past week, however, the market gained confidence that the FOMC would choose 3 percent as its new target.

Equity markets greeted the FOMC decision by swinging wildly. Initially equity prices reacted favorably, jumping almost two percentage points. The excitement was short-lived, however, as prices fell sharply near the end of trading, ending the day down about one-half percentage point.

Although credit terms have tightened further for some businesses and households, concerns about liquidity have lessened substantially. The spread between the term borrowing rate in the London interbank market (LIBOR) and the cash market rate (OIS), is a closely watched indicator of liquidity conditions. Spreads for both one-month and three-month borrowings have declined well off recent peaks, although they remain above more normal levels.

One-Month LIBOR Spread
Three-Month LIBOR Spread

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