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The Fed makes surprise rate cut

Signs of economic slowdown cited; Wall Street rallies

January 3, 2001
Web posted at: 2:58 PM EST (1958 GMT)

In this story:

An unexpected cut

Markets cheer the news


NEW YORK (CNNfn) -- Taking Wall Street by surprise, the Federal Reserve has slashed short-term interest rates, sending signals that it is concerned about the health of the economy and is on guard to prevent a recession.

The central bank lowered the fed funds rate, the rate banks use for overnight loans, to 6 percent from 6.5 percent. The Fed cut the discount rate, which it uses when it loans funds to banks, to 5.75 percent from 6 percent. The unusual move came almost four weeks before the Fed's next scheduled policy meeting, which is to take place Jan. 30-31.

The Fed cited weakening sales, production and lower consumer confidence for its decision.

graphic Focusing on the Federal Reserve

The Federal Open Market Committee, the Fed's policy arm that instituted the cuts, also said it stands ready to approve a further reduction of a quarter of a percentage point in the discount rate to 5.5 percent on the requests of regional Federal Reserve Banks.

"The Committee continues to believe that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future," The Fed said in a statement.

An unexpected cut

Some economists had expected Federal Reserve Board Chairman Alan Greenspan to cut rates before the Federal Open Market Committee meeting, following a spate of economic reports indicating the economy was cooling off much faster than anticipated, with drops in retail sales, consumer confidence and productivity.

But many revised that outlook after some indicators such as sales of existing homes showed that the economy was not in a nosedive and the rate cut likely could hold out until the end of January.

However, a series of severe declines in the markets over the last several weeks driven by increasing fears over earnings shortfalls, high energy prices and disappointing holiday season sales, immediately preceded the Fed's decision Wednesday.

The last time the central bank lowered rates was in November 1998, the third of a string of rate cuts aimed at combating the credit crunch in the wake of the Russian debt crisis and the Long Term Capital Management hedge fund collapse.

The last time the Fed made a surprise rate cut in between Federal Open Market Committee meetings was October 15, 1998.

The series of rate cuts were followed by six interest rate increases between June 1999 and May 2000.

Markets cheer the news

Wall Street responded immediately with a strong rally. Shortly after 2 p.m. EST, the Dow Jones industrial average soared nearly 210 points to 10,853, while the Nasdaq composite index jumped 203 points to 2,495.

"Something like this news is the sort of catalyst that ought to spark a terrific rally now, but the question is will it sustain itself? And that's not at all clear. Certainly in '98 when the Fed did this you had a rally that lasted a year or two. I think we're going into a rally right now," Jim Melcher, founder and president of Balestra Capital told CNNfn's "Market Coverage" on Wednesday.

Some of the nation's largest banks began cutting their prime lending rates minutes after the Fed's announcement.

"This is one of the more surprising moves the Fed has made in a long time," Henry Willmore, chief U.S. economist at Barclays Capital Group told Reuters on Wednesday. "I'm a little bit puzzled by this."

Fed rally on Wall Street
January 3, 2001

Nasdaq Stock Market
New York Stock Exchange
Federal Reserve System board of governors

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