Wall Street yearns for Fed rate cut

By Adam Shell, USA TODAY

NEW YORK — Steps taken by the nation's central bank to restore confidence to jittery financial markets accomplished a key goal last week: It halted the stock market rout on Wall Street.

But many analysts say more help from the Federal Reserve is needed if markets are to successfully navigate the liquidity crunch that first infected the subprime mortgage market but has since spread to corporate debt markets, hedge funds and short-term funding vehicles once deemed conservative.

Wall Street is hoping that Fed Chairman Ben Bernanke will prescribe the same medicine that his predecessor, Alan Greenspan, often did to speed the recovery of ailing financial markets: slash short-term interest rates. That sentiment was summed up by Edward Yardeni, investment strategist at Yardeni Research: "Earth to Fed: Ease now!"

While Yardeni acknowledges that the Fed's job is to keep a lid on inflation — not bail out investors who got burned taking big risks — he stresses that the Fed's No. 1 goal is to restore confidence in the financial system. There is a belief that the current crisis won't fix itself, that serious issues still exist.

On Friday, the Fed took a big step toward reassuring markets when it slashed a key interest rate that it charges banks — the discount rate — to 5.75% from 6.25%. While many analysts called the move symbolic, since few banks actually use the discount window to borrow, it still fueled a 233-point rally in the Dow Jones industrials. The Dow closed at 13,079.08, down just 6.6% from its July high when it topped 14,000.

"The notion that the house is a ablaze and the firemen (the Fed) can't see the smoke has passed," says Bob Barbera, economist at ITG. But problems remain, he says.

Mortgage lenders are still under strain. So are leveraged hedge funds that lost money and are facing redemptions, and bond investors hurt by a sharp increase in corporate borrowing rates.

That's why many investors think the Fed must cut another key interest rate called the fed funds rate. This is the overnight rate, currently 5.25%, banks charge other banks. More important, the fed funds rate influences rates businesses and consumers pay on certain loans, such as credit cards, adjustable mortgages and home-equity lines of credit. A cut would help the ailing bond market most but also lift the stock market, which has been hurt by carnage in bonds, says Chris Orndorff, portfolio manager at Payden & Rygel.

The Fed said Friday it was "prepared to act as needed," to lessen the economic fallout, which suggests a rate cut may come on or before their Sept. 18 meeting.

Historically, the first rate cut by the Fed has been bullish for stocks, both short- and long-term. More important, rate cuts have resulted in big gains for financial stocks, which have been hurt most in the crisis and account for 20% of the market's value. Financials rose 9.1% three months following first cuts dating back to 1990, Citigroup says.

The fact that the Fed has room to cut is positive. "The powder is still dry," says Jon Najarian, analyst at OptionMonster.com.