The Fed announced a ½ point rate cut Wednesday afternoon (January 30) to the Fed fund rate, reducing the rate it charges banks to 3%.  This was the second cut in a week following last week’s surprise .75 point cut.  Financial markets had been widely anticipating the ½ point cut and most economists believe the Central Bank does not want to do anything to upset the market, given recession concerns.

There was little reaction from mortgage lenders as many banks and lenders are still holding near all time lows, with little room to move lower.  The 15 year fixed rate average is back above 5% after a brief stint under 5%, according to Bankrate.com.  Today’s national 30 year fixed average was 5.52%, up from last weeks 5.25% average for the same day.

Many economists speculate there may be little time left for borrowers to take advantage of historically low mortgage rates.  The mortgage market seems to have reached its peak in terms of the ability to drop lower with rate cuts.  The market had basically priced in the 1.25% cut over the last couple weeks and after stabilizing at lows has gradually moved up.

While mortgage rates may have found their bottom, continued rate cuts are still creating great borrowing opportunities in second mortgage, personal loan, and credit card markets.  Additionally, current debtors are seeing reductions in variable rate credit cards and loans, helping them to see lower monthly payments and greater portions of payments going toward their principle balances.

The Dow Jones Industrial Average saw over a 400 point swing today (January 31).  After dropping 190 points early, the Dow was up 250 points in the afternoon, before closing up 207 points.  The strong turnaround was triggered by comments by bond insurer, MBIA.  A day after concerns were expressed in the market about possible fall out for bond insurers, MBIAs chief executive told the market his company should be able to continue to raise capital.

Bond rater Moody’s says it will review the status of many leading bond issuers.  Many experts are concerned that some recent reductions in bond insurer ratings could be a sign that the bond market could be the next domino to fall, after the housing and mortgage struggles.  Investors in bonds essentially loan money to issuers, which are usually government entities or large corporations, at a specified interest rate.  Investors accrue interest over time and upon maturity, receive the original loan amount, plus accrued interest.

Just as banks take on risk when lending money to borrowers, bond investors take on similar risk when putting capital in the hands of bond issuers.  Moody’s and other investor services agencies, rate the credit worthiness of the issuers to let investors know the risk they are taking on.  If an issuer goes bankrupt, or defaults on the bonds, investor capital is at risk.

Any strong signs of bond market trouble could really damage financial markets that seem to have calmed a bit over continued housing and mortgage concerns.  Simultaneous moves by the Fed, with rate cuts, and the government, with its bill in progress for a $146 billion tax rebate, have encouraged investors to hope for the near future.

Fed Chairman Ben Bernanke has given all indications that the Central Bank will continue to respond aggressively to needs for more rate cuts.  The Central Bank is committed to doing what is necessary to help prevent recession, and stimulate the economy, with its support of financial and lending markets.  It may be months before the current rate cuts and tax rebates impact the economy, but some investors seem to be banking on it this week.

Market Recap

The Dow dropped 37 points on Wednesday after a day of moderate trading with the Fed rate cut announcement.  The market was up early, but fell off following the ½ point rate cut.  The economy nearly stalled in the fourth quarter of 2007 as GDP growth was a sluggish .6%.  Amazon gave a boost to the earnings season with a strong profit report, boosted largely by international sales.  On Tuesday, the market resumed its strong bounce since the Dow moved back over the 12,000 mark.  The Dow closed the day up 207 points to 12,650.  The NASDAQ was up 40 points and the S&P 22 on the day.  Google missed its fourth quarter analyst estimates.  Positive bond market news sparked the strong turnaround on the day.

Neil Kokemuller
Thursday, January 31, 2008
7:54 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA.  He has a MBA from Iowa State University with a specialization in marketing.

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