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Monday, 19 March, 2001, 12:58 GMT
Hopes for a US rate cut
Trader shouting
Hey, Mr Greenspan, make that a big cut, will ya?
By BBC News Online's North America Business reporter David Schepp

Financial markets around the world are waiting eagerly for another interest rate cut by the US central bank.

Hopes are high that the Federal Reserve will cut interest rates again on Tuesday, by up to 0.75%, to help revive the slowing US economy.

Expectations were boosted when the Bank of Japan announced on Monday that it was returning to a zero interest rate policy to avert deflation and recession in Japan.

The hope is that lower worldwide interest rates will ease the burden of debt on companies and individuals, encouraging them to spend more and boosting the economy.

In the UK, the Bank of England's Monetary Policy Committee is widely expected to make another rate cut in the spring, perhaps as early as April.

Uncertain impact

But it is not clear that even such a large US rate cut would revive New York's stock market.

In Europe on Monday there was little euphoria, with London, Frankfurt and Paris stock markets all remaining close to the levels at which they ended last week.

The reason for the cautious approach is simple.

Despite an off-the-cuff 0.5% drop by the Fed in early January and a similar one at the end of that month, US markets have continued to slide and investors' fortunes have dwindled.

Alan Greenspan
Market officials would like a cut, but Mr Greenspan has other concerns than stock values
The Nasdaq Composite Index, a technology-stock bellwether, has lost nearly 32% of its value in the last six weeks, falling from a close of around 2,773 on 31 January to 1,891 as of Friday.

The continued drop in US stocks has left investors wondering if there is anything Federal Reserve Chairman Alan Greenspan and the board of governors can do to shore up the nation's stock markets and economy.

Market reaction

"The Federal Reserve is in the business of managing the economy, not the financial markets," says Rich Yamarone, director of economic research at Argus Research.

"Market participants should not wait for a Fed-tossed lifesaver every time the Nasdaq tumbles 100 points."

Market participants should not wait for a Fed-tossed lifesaver every time the Nasdaq tumbles 100 points

Rich Yamarone
director of economic research at Argus Research

In recent weeks, the Fed chairman has also said it is not the job of the Fed to put financial markets at ease.

Still, on Friday, stocks moved steadily lower as traders and investors hedged their bets over what the Fed would do next.

Analysts are placing bets over how far the Fed will go in reducing the Federal Funds rate, from the generally accepted half-percentage point drop to a possible full 1-point slice to 4.5%

"The markets (on Friday) voted in unison that they want to see a 75-basis-points move," says Michael Holland, chairman of Holland & Co.

"For the Federal Reserve to leave the rates at anywhere near 5.5% (for so long) is ludicrous."

Both Mr Holland and Mr Yamarone say they expect the Fed to move further in cutting rates by summer, possibly by another 50 to 75 basis points.

The 'bad' Fed

Mr Holland has been highly critical of the Fed in recent months for its inability to not only drop interest rates, but also for being far too deliberate in loosening its fierce grip on the money supply.

Less cash in circulation means higher interest rates and more stringent loan policies.

In an effort to thwart perceived inflationary threats, the Federal Reserve greatly reduced the money supply last spring, after greatly expanding it the year before, in anticipation of any Year 2000 issues.

The result of last spring's tightening was fewer bank loans and higher interest rates and the start of the tech-stock tumble.

While noting that the Fed did not act alone, Mr Holland says the central bank was party to the problems being experienced by the US economy.

"The combination of higher interest rates and dwindling money supply" has contributed to the economic slowdown and brought the economy to the brink of recession, he says.

Temper tantrum

Argus' Mr Yamarone notes the Nasdaq, in particular, is a little spoiled.

Tech investors "rode this fast surge in asset prices. And now, all of a sudden, we've had this setback, and it was relatively quick. It was as fast going down as it was going up."

That presents a problem, he says, because investors and traders now expect the market to suddenly move higher again in response to cuts in interest rates by the Fed.

"It doesn't happen that way. The economy - and certainly monetary policy - works with long and variable lags," Mr Yamarone says, adding that it is going to take some time for the rate cuts "to work their voodoo."

But according to Alan Skrainka, chief market strategist for Edward Jones, "We'll continue to see aggressive cuts (in the Federal Funds rate) until this economy gets back on track."

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See also:

02 Mar 01 | Business
Greenspan hails tax cuts
28 Feb 01 | Business
Fed: Slowdown not over yet
28 Feb 01 | Americas
Bush pushes tax cuts
31 Jan 01 | Business
US interest rates cut to 5.5%
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