The Federal Open Market Committee (FOMC) unanimously voted Wednesday to lower the federal funds rate by 50 basis points to 1 percent - its lowest level in more than four years.

The Fed, in an accompanying FOMC Statement, also retained a bias toward easing, and has left the door open to additional rate cuts that have not been seen in half a century, putting rates on the once-unthinkable path toward zero.

By and large, the Fed has met market expectations for the size of the cut, but the easing bias shows an expectation for another rate cut. This apparent willingness to cut again, below 1 percent, reflects the unprecedented severity of the global financial crisis that is not only afflicting markets everywhere, but is now having an accelerated impact on consumer and business confidence and the real economy.

Regarding growth, the statement said: "Economic activity appears to have slowed markedly". That conveys the downbeat tone of the Fed's latest assessment. Consumption, investment, and net export trends are all viewed negatively, and financial turmoil is cited as an independent factor that is currently weighing on real spending decisions of economic agents.

Inflation: The Fed "expects inflation to moderate in the coming quarters to levels consistent with price stability".

Risk assessment: The statement lists the various measures taken to restore growth, but it ends saying: "Nevertheless, downside risks to growth remain". That's a clear signal the Fed is open to further reductions in the federal funds target to below 1 percent, though 75 bps is seen by some as a natural floor to interest rates in the US, since anything below this causes viability problems for money market mutual funds.

Independent US research house ISI sees the Fed cutting the funds rate to 0.5 percent in December, if not sooner, via an inter-meeting move. In which case, federal funds futures rates are too high, given another cut in the target rate plus the flood of reserves in the system.

The monetary base has simply soared in recent weeks, which inevitably pulls the effective funds rate below target.

The lowest federal funds futures contract is in January at 0.74 percent. On Wednesday, the effective rate was 0.67 percent, compared with an average of 0.79 over the previous 10 days.

In the short term, equity markets may be unimpressed by the Fed's latest move, as they (quite correctly, in our view) have figured out that short-term rate cuts will do little or nothing to stop final demand from weakening. And even in the medium to long term, the interest elasticity is likely to be far weaker than in the past, as the links via housing, consumer durables and related household expenditures have been severely compromised by the US housing slump.

However, despite this apparent rejection by equity markets, the Fed rate cut is still an important and necessary part of the measures needed to combat the credit crisis.

The author is head of Investor Communications, JF Asset Management.

(HK Edition 10/31/2008 page3)