TOKYO Oct 6 The Federal Reserve could cut
interest rates by a half-point this week because the central
bank may want to do so at the same time as announcing changes to
reserve management after winning the power to pay interest on
excess reserves, Wrightson ICAP said in a research note.
As part of the $700 billion bank bailout bill that passed
Congress last week, the Fed can offer interest on excess
reserves parked at the central bank -- an authority the central
bank has long sought to help smooth intraday volatility in the
fed funds rate.
Lou Crandall, chief economist at Wrightson ICAP and a
well-known money market watcher on Wall Street, said that he
expected the Fed to cut rates 50 basis points this month to 1.5
percent and that it may want to go ahead and pull the trigger
"If the Fed is ready to implement its new authority quickly,
and if it expects to lower its funds target at some point this
month anyway, it would probably combine the two in a single
announcement," Crandall said.
Crandall noted that the effective fed funds rate has
averaged 1.30 percent since Sept. 19, well below the 2 percent
target USFFTARGET=, because the Fed has flooded banks with a
record amount of excess funds to help relieve the near frozen
conditions in money markets.
The Fed paying interest on excess reserves is expected to
help put a floor under the fed funds rate and limit the
end-of-day drops that have seen the effective fed funds rate
plunge down to 0.670 percent late last week USONFFE=.
"It would not make much sense to introduce new structural
measures that would allow the Fed to jack the effective funds
rate back up to 2 percent for a few weeks if the FOMC is going
to cut the target to 1.5 percent anyway," Crandall said.
Crandall said the Fed may set the rate it pays on excess
reserves at 50 basis points below the fed funds target.
Fed Chairman Ben Bernanke said in a statement on Friday that
the central bank would use "all powers at our disposal" to ease
the credit market strains and foster a strong economy.
Even as overnight rates have been shoved lower from the
massive fund injections, banks remain reluctant to lend to each
other much beyond a single day, contributing to the ongoing
strains driving up three-month dollar LIBOR rates USDLIBOR.
The spread between three-month LIBOR and the average
expected fed funds rate in three months USDOIS surged further
to a record 2.98 percentage points on Monday. Before the credit
crisis erupted last August, that spread had typically been less
than 10 basis points.
(Reporting by Eric Burroughs)