January 31, 2008

Overview: Fed move sparks rally on Wall St

Further aggressive moves by the Federal Reserve to bolster the US economy drove Wall Street stocks higher and the dollar lower on Wednesday.

The Fed cut both the Fed funds and discount rates by 50 basis points, to 3 per cent and 3.5 per cent respectively. The moves follow last week's emergency 75bp reduction in the Fed funds.

In its accompanying statement, the US central bank said that financial markets remained under considerable stress and that recent information indicated a deepening of the housing contraction as well as some softening in labour markets.

"Downside risks to growth remain," it said.

Shortly after the moves were announced, the Dow Jones Industrial Average was up xxx per cent, the S&P 500 was xx per cent higher and the Nasdaq Composite was up xxxx per cent.

Short-dated Treasury bonds turned positive, with the two-year yield down 5bp at 2.24 per cent, although longer-dated maturities fell back. The yield on the 10-year bond was up 4bp at 3.72 per cent

The dollar weakened almost across the board, with the euro gaining 0.6 per cent to $1.4865.

The rate decisions followed a mixed bag of US economic releases earlier in the day.

A survey from ADP Employer Services showed that 130,000 private sector jobs were created in January, about three times the expected increase, heightening expectations that tomorrow's crucial non-farm payrolls report could turn out to be stronger than expected.

"ADP has proved itself horribly misleading several times over the past year but the fact remains that it is the best - or least bad, anyway - single advance indicator of payrolls," said Ian Shepherdson, chief US economist at High Frequency Economics.

However, US fourth-quarter gross domestic product growth came in much weaker than expected.

The economy expanded at an annualised rate of 0.6 per cent in the fourth quarter of last year - the slowest pace for five years and down sharply from 4.9 per cent in the third quarter.

Stephen Stanley, chief US economist at RBS Greenwich Capital, warned the fourth-quarter advance was "too close for comfort" given the normal scope of revisions to the initial estimate.

He suggested that assumptions made by the Commerce Department for December trade and inventories data were far too optimistic. "Depending on how the surprises elsewhere break, the fourth-quarter GDP number could easily end up slightly below zero."

Tony Crescenzi, chief bond strategist at Miller Tabak, took a more optimistic view, saying the GDP report showed that business inventories had been "extraordinarily well managed" during the economic slowdown, boding well for the future.

"Inventories are so lean that any increase in spending will almost immediately translate into an increase in industrial output, which, when it occurs, will boost incomes and lead to conditions consistent with sustained economic expansion," he said.

Equity markets in Europe and Asia saw relatively quiet trading as investors the US rate news.

In Asia, an early attempt to build on Tuesday's gains came to nought as uncertainty about the Fed set in. In Tokyo, the Nikkei 225 Average ended 1 per cent lower, while Hong Kong shed 2.6 per cent and Seoul fell 3 per cent to a nine-month low.

European stocks adopted a similarly cautious tone, with fresh writedowns at Swiss bank UBS further damping the mood.

The FTSE Eurofirst 300 index fell 0.7 per cent, although German stocks outperformed as the Xetra Dax shed 0.3 per cent.

European government bonds edged back in quiet trading ahead of the Fed's decision. with the 10-year Bund yield up 3bp at 4.01 per cent. The 10-year Japanese government bond yield fell 4 bp to 1.43 per cent following the slide in Japanese equities.

In commodities, oil prices edged higher after a choppy session as investors reacted to news of a bigger than forecast increase in US crude inventories last week.

March West Texas Intermediate rose 69 cents to $92.33 a barrel.

Gold briefly spiked to within striking distance of Tuesday's record high of $933.10 after the Fed move, but then eased back.

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