High-yield/macroeconomics (fka YIELD)

[Preciouslife1]

Markets set for big Fed rate cut as turmoil persists.
Tue Mar 18, 2008 7:31am EDT

http://www.reuters.com/article/newsOne/idUSN1762124220080318?sp=true

WASHINGTON/LONDON (Reuters) - The U.S. Federal Reserve is expected to slash interest rates by as much as a whole percentage point at its policy meeting later on Tuesday as investors warily await investment bank results that could aggravate fears of a full-blown markets crisis.

Traders expect the Fed to cut rates aggressively in an effort to stop hemorrhaging in financial markets and boost the flagging economy. The Fed is expected to announce its decision around 2:15 p.m..

The Fed has cut overnight rates by 2.25 percentage points to 3 percent since mid-September as a rise in defaults on subprime mortgages has escalated into a financial crisis that this weekend claimed one of Wall Street's most venerable firms, investment bank Bear Stearns, as a victim.

In the midst of what many analysts say is the worst financial crisis in decades, economists and traders expect the Fed to deliver its biggest rate cut since 1982.

In mid-morning trade in London, Fed funds futures contracts were fully discounting a one percentage point cut and indicated a one-in-five chance the Fed will slash benchmark borrowing costs by as much as 125 basis points.

Before the market open, however, investors will focus on the quarterly results from Goldman Sachs Group Inc, the most profitable U.S. investment bank, and Lehman Brothers Holdings Inc, the fourth-largest.

Lehman's stock closed down almost 20 percent on Monday, meaning it has lost some 50 percent of its value this year, as speculation mounts that it might be facing similar mortgage- and leveraged loan-related problems that led to Bear's demise.

Lehman and Goldman are expected to show how badly they were hit by the credit crunch in the three months ended February 29 -- and any major shocks could send markets into another tailspin, especially given the vulnerability of the financial sector exposed by the firesale of Bear Stearns to JPMorgan Chase.

In this environment, markets expect aggressive Fed action.

"Just because we're in uncharted waters doesn't mean the situation can't get worse," Kenneth Broux, financial markets economist at Lloyds TSB in London, said.

"You've got to get rates as low as possible and leave them there. There aren't many alternatives," he said, acknowledging that there were inflationary risks involved in adopting such expansionary policies.

The Fed has already taken a series of radical steps in an attempt to stabilize the financial system.

It narrowed the gap between the discount rate -- the rate at which it lends directly to banks -- and the federal funds rate, the overnight rate banks charge each other for loans and the Fed's main policy tool, from three-quarters of a percentage point to a quarter point.

The U.S. central bank also unleashed a barrage of other unorthodox steps to provide liquidity, including $30 billion in financing to enable JPMorgan to buy Bear Stearns. In addition, it set up a new program to provide cash to a wider range of big financial firms through loans at the Fed's discount window.

Stability returned on Tuesday to European banking shares which have been battered by growing investor concern about the global financial sector's security.

Banks by mid-morning were pushing the broad market higher as the biggest gainers on the FTSEurofirst 300 index of leading European shares, following days of heavy losses.

INFLATION ON BACK BURNER

Against the market upheaval, fears that a seizing up of the financial system could plunge the U.S. economy into deep recession have overtaken worries about inflation fueled by high oil and commodity prices.

"With the recent market turbulence, those inflation concerns are now taking a backseat, and the (Fed) has to think about the action that not only is appropriately aligned with the forecast but that also supports financial markets at a time of extraordinary turbulence and systemic risk," Laurence Meyer, a former fed governor now with forecasting firm Macroeconomic Advisers, said in a note to clients.

The Fed has focused efforts in recent days on surprise steps to make funds available to banks and Wall Street firms, offering hundreds of billions of dollars in auctions and credit to thaw frozen credit markets.

Policy-makers may have hoped that recently announced emergency actions, such as expanded cash auctions for banks and the extension of credit to a wider array of Wall Street firms, would remove the need for a deep interest rate cut. But officials will have to take stock of gloomy data on hiring, factory output and retail sales.

Lehman, which many observers believe is the most vulnerable to troubled mortgages and leveraged loans next to Bear Stearns, is expected to report its quarterly earnings tumbled 63 percent, according to Reuters Estimates.

Goldman Sachs, which in previous quarters succeeded in escaping the worst of the subprime mortgage crisis thanks to some well-timed short bets on subprime debt, is also expected to have run into tougher times over the past few months.

Goldman, Wall Street's top brokerage by market capitalization, is expected to report earnings fell by more than half from the year-ago quarter, and one UK press report over the weekend said it could unveil writedowns of some $3 billion.

And if Goldman and Lehman earnings weren't enough drama for one day, the market will have another major event to chew on late in the day: Visa Inc's initial public offering, the largest U.S. stock flotation ever.