Interest Rates Come Tumbling Down; Lower Discount Rate Seen as Weak Medicine

Article excerpt

Interest Rates Come Tumbling Down

Lower Discount Rate Seen as Weak Medicine

By reducing two key interest rates on Wednesday, the Federal Reserve signaled its determination to recharge the economy. But some experts doubted the move would have the intended result.

The Fed cut the discount rate rate to 4.5% from 5% and reduced its target rate for overnight fed funds to 4.75% from 5%. Banks borrow from the Fed at the discount rate and lend overnight to each other at the fed funds rate.

Dozens of banks took a cue from the Fed and cut their prime lending rates to 7.5% from 8%.

Bush administration officials applauded the moves, which were expected for nearly a week.

"Lower interest rates will provide stimulus for economic growth, spur incentive for business investment, and increase consumer confidence," Treasury Secretary Nicholas Brady said in a prepared statement.

The long-term bond market displayed less enthusiasm. Although short-term rates fell, long term rates barely moved. The 30-year bond was trading at 8% Wednesday afternoon, two basis points below Tuesday's.

A Sharp Yield Slope

The yield curve is now more steeply sloped than it has been in years - "a ski slope," according to one economist.

That means investors are still worried about the high volume of government borrowing and the long-term outlook for the debt-heavy U.S. economy. They are going to continue to demand high rates on long-term securities, thereby keeping interest rates at levels guaranteed to put a damper on capital spending.

"The financial imbalances in our economy will simply take time to work themselves out," said Henry Engler, a vice president and money market economist at Chemical Banking Corp. "The accumulation of debt in the 1980s was high, and it will take a number of years for households and businesses to rebuild their balance sheets."

No Long-Term Lever

The Fed has no direct means of influencing long-term rates, which are governed by factors such as investors' worries about inflation and the supply of Treasury securities. And the government's large and growing deficit is being financed with huge sales of Treasury notes and bonds.

As a result, the yield on the 30-year Treasury bond is down just a quarter of a point since the beginning of the year, compared with a drop of two-and-a-half percentage points in the overnight fed funds rate. …