Fed to investors: More cuts coming

NEW YORK - The Federal Reserve hinted Wednesday in minutes from its latest meeting that more interest rate cuts might be needed if the deterioration in the credit markets leads to deeper problems for the housing sector and overall economy.
But the news from the Fed on Wednesday did little to soothe Wall Street, which kicked off 2008 more concerned about a recession and rising inflation. The Dow fell more than 220 points, or 1.7 percent, while the S&P 500 and Nasdaq fell 1.4 percent and 1.6 percent, respectively.
The central bank lowered its key federal funds rate - an overnight bank lending rate that affects how much consumers pay for credit cards, home equity lines, auto loans and other forms of credit - by a quarter of a percentage point on Dec. 11 to 4.25 percent.
That marked the Fed's third consecutive rate cut since September as the central bank attempts to deal with the subprime mortgage meltdown, which has caused cash-strapped consumers to default on their loans and banks to report billions of dollars in losses tied to bets on bad mortgages.
In the minutes, the Fed said that "some members noted the risk of an unfavorable feedback loop in which credit market conditions restrained economic growth further, leading to additional tightening of credit" and added that "such an adverse development could require a substantial further easing of policy."
Read the Fed minutes
As such, traders are now betting that a rate cut at the Fed's next meeting, a two-day session that concludes on Jan. 30, is certain. The question is simply how big of a cut it will be.
According to futures listed on the Chicago Board of Trade, investors are pricing in a 100 percent chance that the Fed will lower the federal funds rate by another quarter-point to 4 percent and a 63 percent chance that the central bank will lower rates a half-point to 3.75 percent.
One economist said there is a growing sense that even continued rate cuts won't cure what's ailing the market.
"I'm not sure if we can judge that it's too little too late, but what is clear is that there are more things to be nervous about, such as more writedowns from banks and weak holiday sales," said Tom Higgins, chief economist with Payden & Rygel, a Los Angeles-based money management firm.
"People are factoring in a higher risk of recession and that's weighing on the market, even with expectations that the Fed will be accommodative," Higgins added.

Karachi shares fall after killing

The Karachi Stock Exchange's benchmark 100 share index opened 4.7% lower on Monday in the first trading since the assassination of Benazir Bhutto.

The exchange had been closed for a three day period of national mourning that began on Thursday.
By mid-morning the KSE100 index had fallen 677.7 points to 14,094.38.
Traders say that the declines might be reversed if a deal can be reached with opposition leaders to allow the 8 January elections to go ahead.
Pakistan's currency has also fallen with the rupee at 61.85 to the US dollar, which is its weakest level since October 2001.
"This is a historic fall and is reflective of the unrest in entire country," said Nabeel Jafar from Zafar Moti Capital Securities.
"When there is killing of political leaders and riots after that, who is going to invest in the market?"
Before Monday's falls the KSE100 had risen about 47% in 2007.The Karachi Stock Exchange had already closed on Thursday before Ms Bhutto was assassinated but stock markets elsewhere in the world were hit with New York's Dow Jones average falling 192 points, or 1.4%.
At the same time, the prices of so-called "safe haven" investments such as gold and government bonds rose. The Karachi stock market has a history of recovering after political unrest. When a state of emergency was declared on 3 November, the market fell about 10%, but then regained most of its losses.

Insight: Europe’s banks will herald eurozone crisis

The announcement before Christmas by the world’s central banks of further measures to help restore liquidity to money markets was at first greeted with euphoria.
But, as with the US Federal Reserve’s August 17 discount rate cut, it was not long before the measures were viewed as likely to be inadequate to deal with the size of the problem. The shift by the Fed to providing term liquidity via auctions has taken a leaf out of the European Central Bank’s liquidity management manual. It may help. But with euro-area money markets having remained stressed – even after the extraordinarily big liquidity injections over the year end – it seems that money market liquidity provision alone is unlikely to solve the problem.
Should the financial crisis persist in spite of central banks’ best efforts, the general perception is that the European economy would be less vulnerable than the US economy to its effects. That Europe has not generated on a large scale its own subprime asset class, the proximate cause of the recent difficulties, underpins this analysis. While some European banks might have been contaminated with subprime assets, it is argued, the waste is unlikely to be toxic enough to trigger a full-scale credit crunch. At the ECB’s December press conference Jean-Claude Trichet, its president, suggested that still-strong bank lending might be an indication that “the supply of credit has not been impaired”. The reality is more complicated.
At this stage, the challenge is to gauge the magnitude of the strains in the banking system and the extent to which future lending will be curtailed. The recent strength of bank lending in the euro-area reflects both re-intermediation and the difficulty of raising new finance in capital markets. It is therefore a sign of weakness, not strength, as it places even greater stress on bank balance sheets. A better measure of the credit squeeze is one that combines all capital-raising activities. The rate of increase in capital raised by companies in the previous 12 months in the form of bank loans, net debt and net equity issuance, for example, posted a drop of €57bn ($83bn) between July and September, the biggest two-month decline since mid-2001, and was followed by only a modest recovery in October.
There are numerous other signs of an emerging credit squeeze. The rates that banks charge on loans have been creeping up despite the ECB having kept its policy rate on hold. Since July, the interest rate charged on loans to companies has increased by 25 basis points. The rate charged on mortgages has gone up by 17bp. Combining these metrics into an overall index, we find that bank credit conditions have tightened sharply and now stand at levels last seen in mid-2004. One hopes the new balance sheet and liquidity constraints facing European banks will not be too great to bear. In making our euro-area forecasts, we have calibrated the short-term effect to be equivalent to about a 75bp rise in interest rates that will be gradually eliminated by the end of 2009. That is more than most central banks and international institutions are assuming, and consistent with much slower bank lending next year. But in assessing the vulnerability of an economy to tighter credit it is necessary to gauge not only the extent to which banks will restrict their lending but also the importance of bank lending for financing economic growth.

According to the International Monetary Fund, about 60 per cent of private-sector liabilities in the euro-area and the UK consists of bank loans, while only 40 per cent is debt and equity. The 60 per cent figure for bank loans is higher than that of Japan’s economy, where a broken banking system has contributed to more than a decade of poor economic performance. By contrast, bank loans account for only 20 per cent of private-sector liabilities in the US, with the rest accounted for by debt and equity.
This matters a lot. It means that, were banking systems to retrench significantly, the consequences for the economy are likely to be far greater in Europe than in the US. By symmetrical reasoning, however, the European economy is less vulnerable to a capital markets freeze than is the US. The lesson: in the US, watch the markets; in Europe, watch the banks.