Concerns of a relapse in financial conditions trumped hawkish rhetoric from the minutes of the U.S. Federal Reserve's October rate meeting, keeping market expectations for a near-term interest-rate cut intact.
Minutes from the October 30-31 Federal Open Market Committee meeting showed the Fed's decision to cut benchmark rates last month was a close call and an insurance policy against the risk the economy would weaken even more than officials expect.
But market participants, focused on fresh signs of stress in credit markets, brushed off the rhetoric as old news.
There is no way that the FOMC was confident of anything, so that just because they thought they might be done (cutting rates) on October 31 does not mean anything today or certainly on December 11 or January 30, said Stephen Stanley, economist at RBS Greenwich Capital, referring to the Fed's next two policy meetings.
Dealers, instead, focused on more negative news in the credit sector. U.S. mortgage finance company Freddie Mac posted an unexpectedly wide third-quarter loss, triggering falls in shares of a number of lenders. Citigroup shares closed down 1.9 percent after earlier falling to about a five-year low.
The market's focus remains on the financial stresses, said John Spinello, Treasury bond strategist at Jefferies & Co. in New York.
Interest rate futures showed a 92 percent chance that the Fed will cut interest rates by one-quarter point to 4.25 percent on December 11. That was up from as low as 70 percent earlier in the day.
It is clear they'd rather not ease again on December 11, but it is equally clear that fine, considered speeches count for naught when the sky is falling, said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York.
We can be pretty sure that if the outlook continues to deteriorate and markets remain distressed, they'll be easing again soon enough, he said.
Merrill Lynch said in a research note on Tuesday that it now expected the benchmark federal funds rate to reach 2 percent by the middle of 2009.
New three-year economic forecasts from the Fed showed that policy-makers expect core inflation to stay below 2 percent all the way through 2010, which should give the central bank leeway to lower rates as needed to shore up the economy.
The FOMC cut its benchmark lending rate to 4.5 percent in October, a second consecutive interest rate cut.
The Fed also projected economic growth to slow in 2008 to between 1.8 percent and 2.5 percent, sharply down from the 2.5 percent to 2.75 percent forecast in June.
But some market players said the information was simply too dated to be relevant.
Even though that was only three weeks ago, I think at this point the minutes are very out of date because so much has transpired since then, said Mary Ann Hurley, vice president of fixed-income trading at D.A. Davidson & Co in Seattle, Washington.
(Additional reporting by Ros Krasny in Chicago; editing by Leslie Adler)