The Fed Rate Cut: What You Need to Know

The need-no-sleep Federal Reserve policymakers voted unanimously for a half-percentage-point cut in the federal funds rate this afternoon. Here's what you need to know:

The gist: The Fed dropped its key interest rate from 1.5 percent to 1 percent in a bid to boost economic growth and increase the availability of credit. Today's rate cut follows a 50-basis-point reduction earlier in the month, when the Fed acted in concert with several central banks around the world to address what has clearly become a global credit crisis.

The Fed's decision met the expectations of a market that had rallied considerably in anticipation of the cut. The Dow gained 890 points Tuesday and was up another 230 points today immediately after the announcement. (A sell-off shortly before the close left the index down for the day.) Notably, in its statement, the Fed hinted at further rate cuts to come.

What it means: The Fed clearly doesn't like what it sees in the broad economy. Its statement points to tight credit amid market turmoil, as well as declines in consumer spending, business equipment spending, and industrial production. The Fed also expressed a new concern about weakened economies abroad "damping the prospects for U.S. exports." The last time rates were slashed to 1 percent was 2003, when the market was trying to recover from the bursting of the tech bubble and to soothe investor anxieties after the 9/11 attacks. The rate cut comes on the heels of several ugly economic reports, including a record decline for the S&P/Case Schiller 20-city housing index for August and a record low for the Conference Board's monthly measure of consumer confidence.

What the pros are saying:

Ian Shepherdson, chief U.S. economist at High Frequency Economics
"The rate cut is accompanied by a very downbeat statement, with all mention of upside inflation risks expunged from the record. Indeed, the statement says that the drop in commodity prices and the deteriorating growth outlook mean 'the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.' Moreover, the door is open to further easing, with the [Open Market Committee] stating baldly that 'downside risks to growth remain,' thanks to the decline in consumption, 'weakened' industrial activity and worsening export prospects. In short, we view this as the first entirely realistic assessment from the Fed in this whole cycle. We expect another 50 [basis point drop] on December 16."

Robert Brusca, chief economist at FAO Economics
"The Fed cut the discount rate by 50[basis points] as well and it got requests for FOUR district banks out of twelve on that. When the number of discount rate cut requests diminish[es], it is often a sign that the string of rate cuts is over."

Goldman Sachs U.S. Economic Research:
"The most significant change in the statement announcing this move was the downgrading of inflation as a policy concern. Whereas the September 16 statement following the last formal meeting had indicated virtual parity between growth and inflation worries, this statement did not even mention inflation in the final paragraph summarizing the committee's policy framework.... Both the acknowledgement of growth as the main worry and the promise to "act as needed to promote sustainable economic growth and price stability" imply the possibility of additional rate cuts. At the moment, we think the bar to such cuts is probably high as suggested by the small number of banks applying for a 50[basis point] rate cut, and we are not forecasting more easing as a central scenario. However, risks clearly lie in this direction."

Bernard Baumohl, chief global economist at the Economic Outlook Group
"The latest Fed move is not going to hasten the economic recovery by a single day or accelerate the cleansing of bank balance sheets. What is needed more than anything else at this stage is simply patience....

"Tomorrow we'll get GDP growth for the third quarter and we're looking for a contraction of 0.8%, largely on the decline of consumer expenditures—the first drop since 1991—along with slipping inventories and exports. We expect conditions will get even worse in the final quarter, with GDP growth contracting by 3%. The recession should bottom out in the first half of next year, as the emergency financial rescue package and the monetary stimulus work their way into the economy. This is not to say we'll see stellar growth in the second half of the year. Growth will remain below potential at least until mid 2010, which means joblessness will continue to rise next year, to 8%."

Michael Woolfolk, senior currency strategist at the Bank of New York Mellon
"While the rate cut was consistent with expectations, the statement did little to signal the Fed's future intentions. Still, the Fed maintained downside risk to growth and removed its upside risk to inflation, which suggests the possibility of further rate cuts. The Fed clearly did not want to disappoint markets today by failing to cut rates. The futures market had discounted a 100% probability of a 50 bps rate cut and approximately a one-third chance of a 75 bps cut. The statement was reworked, but not to the degree that market conditions probably warranted."