Investors strive to read Fed's intentions

on August 22 2007 8:54 AM

Investors sought to gauge on Wednesday the prospects of a near-term U.S. rate cut to calm a financial storm stemming from America's faltering home loan market, as some experts said the world economy would take a hit.

There were mixed messages about the Federal Reserve's intentions following last week's half-point cut in its discount rate, which governs its loans to banks, a move which helped battered stock markets claw back some lost ground.

Speculation the Fed might cut its benchmark interest rate soon was fired by Senator Christopher Dodd, chairman of the U.S. Senate Banking Committee, who said Fed Chairman Ben Bernanke had told him he would use all available tools to calm the markets.

Dodd met Bernanke and U.S. Treasury Secretary Henry Paulson on Tuesday to discuss market turmoil.

But nothing was heard from Bernanke himself and Richmond Federal Reserve Bank President Jeffrey Lacker dampened hopes for an imminent rate cut.

Financial market volatility, in and of itself, does not require a change in the target federal funds rate, in my view, he said. Interest rate policy needs to be guided by the outlook for real spending and inflation.

The Wall Street Journal reported on Wednesday that Fed officials were cautiously optimistic the steps they have taken to relieve a squeeze in credit markets were working and may wait until their next policy meeting before considering a rate cut.

The paper said Fed officials acknowledged conditions could take a turn for the worse but a pick-up in issuance of jumbo mortgages and steadying equities suggested improving conditions.

Market speculation has been feverish that the U.S. central bank could cut its fed funds rate before its regular meeting.

We think the Fed is further away from an emergency cut than perhaps the market does at the moment, said Jim Reid, a credit strategist at Deutsche Bank. The Fed will want to see how their action regarding cutting the discount rate will impact the market before engaging in more serious measures.

ECONOMY UNSCATHED?

Japanese Finance Minister Koji Omi, on a visit to South Korea, said the global economy was solid but financial markets needed to be watched closely, even though liquidity problems had been addressed by a massive injection of central bank funds.

The world's economic fundamentals remain sound, he said.

Paulson said on Tuesday the world economy was strong but admitted growth would now be lower than it otherwise would have been and that it would take time for market turmoil to play out.

IMF First Deputy Managing Director John Lipsky, meanwhile, told the Financial Times global growth would surely take a hit.

This undoubtedly will dampen economic growth, he said. It will ... take some time for markets to restore a normal amount of volatility, he said.

Germany's DIHK industry group said the European Central Bank should not tighten borrowing costs at its meeting next month as there were signs the credit crisis would curb growth.

A ZEW think tank survey showed the credit squeeze pushed German investor morale to its lowest in eight months in August.

Interest rate expectations have lurched dramatically since problems in the U.S. home loan market threatened a wider liquidity crisis and sent markets into a tailspin.

Analysts expect the Bank of Japan to sit tight at a two-day meeting starting Wednesday. It had previously been expected to raise to 0.75 percent from 0.5.

Investors remain braced for further corporate crises to emerge from the U.S. subprime mortgage market.

First Magnus Financial Corp, one of the largest independent U.S. mortgage lenders, filed for Chapter 11 bankruptcy protection on Tuesday, the latest home loan provider to collapse as the housing market slumps and the credit crisis widens.

The Bank of England lent 314 million pounds through an emergency lending facility this week. Sources familiar with the matter said Barclays Plc, had used the facility, although they said it was not related to liquidity concerns.

Investors are just waiting for some big, bad news to come out, said Leslie Khoo at Forecast PTE in Singapore.

But some traders saw grounds for optimism after BNP Paribas said it planned to re-open by the end of August three investment funds frozen earlier this month because their net asset values could not be calculated.

BNP's action on August 9 helped set off a flight to safe haven assets that sapped confidence and liquidity from money markets. The ECB stepped in later that day and pumped in a record 94.8 billion euros ($131 billion) to calm fears of a credit crunch.

Financial markets were mixed but appeared to have taken some solace from hopes that the Fed would not stand idly by.

U.S. stock futures showed Wall Street was set for a positive start and European shares rose on Wednesday -- the FTSEurofirst 300 index of top European shares up 1.1 percent.

But Tokyo's Nikkei average ended flat.

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