Fed Cuts 50 Points, Stocks Whipsaw

Updated to reflect Wednesday’s closing prices.

The Federal Reserve cut interest rates by 50 basis points. In a unanimous decision, the target for the federal funds rate was lowered to 1%. The discount rate was also cut by 50 basis points to 1.25%.

The Dow Jones Industrial Average (^DJI), after being up as much as 150 points earlier in the day, dropped into negative territory in reaction to the Fed’s announcement. The Standard & Poor’s 500 Index (^GSPC) and the Nasdaq Composite Index (^IXIC) also initially traded lower following the rate cut.

Late in the trading day, all three indexes rebounded to new session highs before finally giving back those gains in the closing minutes. The Dow had hit the upper end of its recent trading range and this may have prompted some traders to lock in profits.

In explaining the decision, the Federal Open Market Committee opined:

“The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports.

“Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.”

Furthermore, the Fed completely backed away from its fight against inflation. Gone is language proclaiming “weaker prospects for economic activity have reduced the upside risks to inflation.” In its place, the Fed is now saying that it expects inflation to “moderate in coming quarters to levels consistent with price stability.” This change leaves the door open for further rate cuts, if needed.

Kudos to the Fed for continuing to be proactive. Though the recent drop in London interbank offered rates (LIBOR) and the continued monetary support of banks and other financial institutions has a much greater impact on thawing the credit freeze, today’s cut reaffirms the notion that the Fed is willing to do whatever it takes.

Have no doubt, history will be critical of what the Fed is doing now, but in a crisis situation action is always better than no action.

Investors should expected more volatility in the Dow and the S&P 500. Though I continue to believe that the intraday lows established on Oct 10 were at a least a short-term bottom for the indexes, storm clouds remain. Earnings estimates are being cut across the board for 2009, and the economy will worsen before it gets better.

Therefore, investors should remain selective about what stocks they purchase. Think large-cap, less economically sensitive stocks such as Abbott Laboratories (ABT) instead of cyclical stocks such as Caterpillar Inc. (CAT).

The statement from today’s meeting is available on the Fed’s website.

Subscribe by RSS Subscribe by Email