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Fed Takes 50 Off the Top

Citing concerns about capital spending, the Federal Reserve cut its short-term interest rate target today by 50 basis points, or one-half a percentage point. The reduction is the Fed's fifth half-point cut this year.

Chair Alan Greenspan has now overseen the quickest series of rate cuts in his 14-year tenure, dropping the overnight federal funds rate from 6.5% to 4% since early January. With today's move, the fed funds rate is now the lowest it has been in seven years.

In typically wacky fashion, the Fed noted in its statement that while a "significant reduction in excess inventories seems well advanced" and "Consumption and housing expenditures have held up reasonably well.... Investment in capital equipment... has continued to decline. The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook, seems likely to hold down capital spending going forward."

Since a cut of 50 basis points was generally expected, the markets paid particularly close attention to the Fed's "bias," the direction the Fed is leaning regarding future actions. Today's statement indicates that the Fed sees continued economic weakness as a greater threat than inflation, and so it may cut rates again when its Open Market Committee meets again on June 26. This gave the markets a quick but short-lived boost.

So what's the big deal?
Generally, a cut in the federal funds rate helps the economy by reducing the cost of borrowing for businesses and consumers (for more on this, check out our Special on Alan Greenspan and the Federal Reserve). A Fed rate cut usually leads to subsequent reductions in a variety of other interest rates, including those for mortgages, car loans, and even credit card rates.

Given the emergence of individual investing as something akin to a national pastime, and the dramatic impact of the market's downturn in the past year, it's not surprising that the Fed's announcements have become closely watched spectacles. However, as Bill Mann argues today, investors can gain as much, or more, insight into the economy and their investments from paying attention to what individual companies are doing.

Chris Rugaber's holdings can be seen online, as can the Fool's disclosure policy.


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