Market cheers US discount rate cut

Paul Niven, Head of Asset Allocation, at F&C Investments comments on today's cut in the discount rate by the US Federal Reserve: "The US Federal Reserve has today cut its discount rate (the rate at which the central bank makes direct loans to banks) by 50bps today to 5.75% from 6.25%. The target Fed Funds rate remains unchanged, for the time being, at 5.25%. It is the first intra-meeting reduction in borrowing costs since 2001 and the first reduction since June 2003.

The Fed cited deteriorating financial market conditions, tighter credit conditions and increased uncertainty as drivers that may potentially restrain economic growth going forward. With downside risks to growth increasing materially, financial markets mal-functioning and market volatility being at levels last seen more than four years ago, the Fed was quick to act, in order to achieve two of its central aims, namely growth and financial markets stability. As for the other important aim, price stability, the recent benign inflation data (for both consumer and producer prices) had left the Fed with enough room to act decisively and ahead of its next scheduled meeting on September 18.

The move, which has been the subject of much market speculation in recent days and had already been discounted to take place by September, has been welcomed by financial markets.

There are already signs of tentative confidence and liquidity improvement, following a period of exceptional volatility and investor panic.

Appetite for riskier assets, including equities and some selective currencies, is beginning to return, while safer assets, like sovereign bonds, being less preferred.

The emergency move by the Fed should be followed by cuts in the Fed Funds Rate going forward, but investors will likely remain concerned over whether the Fed's actions will enable normal market conditions to return; they will also continue to fret over the implications of the recent credit crunch to the underlying economy.

Nonetheless, volatility in financial markets should retreat somewhat, and while we do not expect a rapid return to previous equity market highs, the outlook for riskier assets now appears more attractive although still rather bumpy for some time to come."