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Market turmoil: Fed set for big rate cut

The US Federal Reserve may slash interest rates by a whole percentage point to boost the flagging economy.
Reuters | By Mark Felsenthal and Christian Plumb, Washington/ New York
UPDATED ON MAR 18, 2008 01:25 PM IST

The US Federal Reserve is expected to slash interest rates by as much as a whole percentage point at its policy meeting on Tuesday as investors warily await investment bank results that could aggravate fears of a full-blown markets crisis.

Traders expect the Fed to cut rates by a full percentage point in an effort to stop hemorrhaging in financial markets and boost the flagging economy. The Fed is expected to announce its decision around 2:15 p.m. EDT.

The Fed has cut overnight rates by 2.25 percentage points to 3 per cent since mid-September as a rise in defaults on subprime mortgages has escalated into a financial crisis that this weekend claimed one of Wall Street's most venerable firms, investment bank Bear Stearns, as a victim.

While financial markets expect the Fed to fire off its biggest rate cut since 1982, they might focus more on the quarterly results due hours earlier from Goldman Sachs Group Inc, the most profitable US investment bank, and Lehman Brothers Holdings Inc, the fourth-largest.

The banks are expected to show how badly they were hit by the credit crunch in the three months ended February 29 -- and any major shocks could send markets into another tailspin, especially given the vulnerability of the financial sector exposed by the fire sale of Bear Stearns to JPMorgan Chase.

The Fed has already taken a series of radical steps in an attempt to stabilize the financial system.

It narrowed the gap between the discount rate -- the rate at which it lends directly to banks -- and the federal funds rate, the overnight rate banks charge each other for loans and the Fed's main policy tool, from three-quarters of a percentage point to a quarter point.

The US central bank also unleashed a barrage of other unorthodox steps to provide liquidity, including $30 billion in financing to enable JPMorgan to buy Bear Stearns. In addition, it set up a new programme to provide cash to a wider range of big financial firms through loans at the Fed's discount window.

Inflation on back burner

Against the market upheaval, fears that a seizing up of the financial system could plunge the US economy into deep recession have overtaken worries about inflation fueled by high oil and commodity prices.

"With the recent market turbulence, those inflation concerns are now taking a backseat, and the (Fed) has to think about the action that not only is appropriately aligned with the forecast but that also supports financial markets at a time of extraordinary turbulence and systemic risk," Laurence Meyer, a former fed governor now with forecasting firm Macroeconomic Advisers, said in a note to clients.

The Fed has focused efforts in recent days on surprise steps to make funds available to banks and Wall Street firms, offering hundreds of billions of dollars in auctions and credit to thaw frozen credit markets.

Policy-makers may have hoped that recently announced emergency actions, such as expanded cash auctions for banks and the extension of credit to a wider array of Wall Street firms, would remove the need for a deep interest rate cut. But officials will have to take stock of gloomy data on hiring, factory output and retail sales.

Lehman, whose shares closed down 19 per cent on Monday on concern that it is the most vulnerable to troubled mortgages and leveraged loans next to Bear Stearns, is expected to report its quarterly earnings tumbled 63 per cent, according to Reuters Estimates.

Goldman Sachs, which in previous quarters succeeded in escaping the worst of the subprime mortgage crisis thanks to some well-timed short bets on subprime debt, is also expected to have run into tougher times over the past few months.

Goldman, Wall Street's top brokerage by market capitalization, is expected to report earnings fell by more than half from the year-ago quarter.

And if Goldman and Lehman earnings weren't enough drama for one day, the market will have another major event to chew on late in the day: Visa Inc's initial public offering, the largest U.S. stock flotation ever.

(Editing by Leslie Adler)

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