All eyes on Fed ahead of next meeting

By Ros Krasny

CHICAGO (Reuters) - A radical shake-up on Wall Street and heavy losses in financial markets have recast the debate for Tuesday's Federal Open Market Committee meeting to set interest rate policy.

Fed officials will assemble as a storm rages over the global financial system, overshadowing discussion of such bread-and-butter issues as the medium-term growth and inflation outlook.

As recently as Friday, analysts had expected the Fed to keep benchmark interest rates steady on Tuesday as it weighs a sputtering economy and an ebbing of inflation pressure.

On Monday, however, bets that the Fed will be forced into a quarter-point cut to the federal funds rate, to 1.75 percent from 2 percent, were rising. Dealers now see more than an even-money chance of a rate cut.

"Fed views have swung dramatically in response to the gut-wrenching developments," said Marc Chandler, currency strategist at Brown Brothers Harriman in New York.

The FOMC held rates steady when the panel met in June and August, after lowering them in April. That cut bought the fed funds rate down by a cumulative 3.25 percentage points from mid-September 2007.

Following are some factors policy-makers are considering:

FINANCIAL INSTITUTIONS:

Wall Street is in crisis mode. On Sunday, investment bank Lehman Brothers Holdings Inc LEH.N filed for bankruptcy, triggering fears of cascading losses across a range of financial institutions.

Lehman's demise came a week after the government crafted a rescue plan for U.S. mortgage finance companies Fannie Mae (FNM.N) and Freddie Mac (FRE.N), which had been brought to their knees by the housing market collapse.

Late on Sunday, the Fed announced a slate of measures to enhance its liquidity provisions and keep the financial system afloat as the global credit crunch, now in its second year, seems to be getting worse, not better.

U.S. stock markets were hit hard on Monday. The Dow Jones industrial average .DJI tumbled more than 2 percent.

ECONOMY TEETERS

The U.S. unemployment rate spiked to 6.1 percent in August from 5.7 percent in July, a surprise move to the highest level in almost five years. Employers cut payrolls by 84,000 nonfarm jobs for an eighth straight month of declines.

Revised figures showed second-quarter growth was a strong 3.3 percent as consumer spending got a lift from the government's tax rebate checks. But most pundits see the result as transitory and expect growth to slow again.