Effects of Rate Cut

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Investors Hunt for Effects of Rate Cut

NEW YORK (AP) — A big rate cut by the Federal Reserve and the stock market’s huge rally in response to that move has many on Wall Street wondering: Now what?

The Fed’s decision Tuesday to slash its benchmark federal funds rate by a larger-than-expected half percentage point sent stocks soaring and lifted the Dow Jones industrials nearly 336 points. It also raised questions about the Fed’s next step and how markets might fare in the coming months.

“I think it’s probably going to help stabilize things. It seems to me that the Fed had enough room on the inflation front to really get out ahead on this,” said Bruce McCain, head of strategy for Key Private Bank’s investment management unit.

Before the Fed’s decision and even with recent moves to cut the rate it charges to loan directly to banks — known as the discount rate — Fed Chairman Ben Bernanke left some investors asking whether the central bank would cut rates at all in the face of concerns about inflation.

With that question answered, investors rushed in and put stocks a good deal above their recent lows in August. The Dow’s jump — its biggest one-day point gain in almost five years — left the blue chip index only about 1.9 percent below its record close of 14,000.41 reached in mid-July.

Still, some on Wall Street will likely question whether the Fed’s rate cut signals a deeper unease at the bank about the effect of tightness in the credit markets and widespread weakness in the housing sector.

And investors will be left trying to determine whether a portion of Tuesday’s rally owed to short covering. Investors who sell shares short bet the stock price will fall, and when stocks move higher, so-called short sellers are forced to move in and buy to cover their losses. That influx of buyers can exacerbate market climbs.

“The market’s initial response is ‘Thank you, Ben,'” said Jerry Webman, chief economist at Oppenheimer Funds Inc. “But we also know that when people stop and look at this, people might say, ‘Could this house of cards be shaky, more than even we thought it was?'”

Still, there was clearly relief that that the Fed seemed to riding in to rescue the credit markets and shore up investor sentiment. Many investors had been pulling for a rate cut to help reduce the chance of the economy sliding into recession.

“They are concerned about the deteriorating real estate market,” McCain said of the Fed. “That is going to continue to weigh on the consumer. I think they felt by being pre-emptive that they could give a lift to confidence.”

In the economic assessment accompanying its decision, the Fed said it remains concerned about the credit market and its effect on housing, It noted in its statement, “The tightening of credit conditions has the potential to intensify the housing (market) correction and to restrain economic growth more generally.”

With those concerns in mind, the Fed cut the benchmark fed funds rate to 4.75 percent — the first reduction in four years. The central bank had kept rates unchanged for more than a year. The Fed also again cut the less-visible discount rate. Fed policymakers lowered the discount rate by half a point in mid-August in their bid to keep cash flowing into the U.S. banking system and dispel perceptions that turning to the central bank for a loan in such times was a sign of a bank’s precarious position.

But while investors will likely celebrate overall cheaper access to liquidity and the notion that dealmaking in an uncertain economy could become less onerous, some of the troubles that have dogged investors can’t be waved away by the Fed’s decision.

Consumers will likely be helped, for example, by seeing lower interest rates on debt such as credit cards, but weakness in the housing sector will likely remain. While the boost to investor confidence is often immediate, Fed interest rate moves often take six months or more to fully work themselves into the economy.

“I think a lot of people are assuming that with a rate cut we go back to the environment you would have coming out of a recession. This was an economy that wasn’t weak but it clearly was a mature economy. You don’t have the pent-up demand that you have after a recession.”

And as the Fed didn’t offer any overt signals about whether it expected to make further cuts, investors will likely continue to pay close attention to economic data on inflation, one of the Fed’s main priorities.

“In part they’re saying the housing problems are going to take the pressure off inflation for the next few months,” McCain said.

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