11.01.2008 00:00 Real Estate
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Ben Bernanke, the Fed chairman, opened the door to a 50 basis point rate cut at the end of the month in light of recent changes in the outlook for and the risks to growth.
"Clearly, the catalyst for the shift in the policy message is the deteriorating economic climate, specifically the risk that deterioration in the labour market could negatively impact consumer demand," said David Greenlaw, economist at Morgan Stanley.
That arrested a slide in US stocks, but the dollar fell, and a sharply steeper Treasury yield curve and gold at a fresh record high reflected higher inflation concerns among investors.
Alan Ruskin, chief strategist at RBS Greenwich Capital, said: "Mr Bernanke has clearly given up managing market expectations here, for he is apt to have further boxed the Fed into a 50bp move, for anything less will tend to disappoint the markets at this juncture," he said.
US equities initially forged ahead and then received a second wind when talk emerged that Bank of America was in discussions to buy Countrywide.
Late in New York, the S&P 500 had closed up 0.8 per cent after earlier trading sharply lower. The Dow Jones Industrial Average ended 0.9 per cent higher.
The Countrywide news also helped alleviate growing concerns about the state of counterparty risks between financial institutions said traders. Such fears had pushed a basket of US investment grade credit default swaps to a record high this week. Late in New York, the US CDX index had eased to 93 basis points from a high of 102bp.
The rally on Wall Street came too late to help European stocks, however, and the FTSE Eurofirst 300 index ended 0.9 per cent weaker.
Asian markets also suffered from a fresh bout of nervousness. In Tokyo, the Nikkei 225 Average fell 1.5 per cent to an 18-month low - leaving it 6 per cent down from the start of the year.
US government bonds were mixed after Mr Bernanke's remarks and the rally in stocks. The yield on the rate-sensitive two-year US Treasury fell 3 basis points to 2.69 per cent. Interest rate futures reflected the Fed funds rate falling towards 3 per cent by the middle of the year. Meanwhile, inflation concerns sent the 30-year yield up 12bp to 4.44 per cent.
On the currency markets, the euro climbed above the $1.48 level on a combination of Mr Trichet's hawkishness and Mr Bernanke's dovish remarks. Sterling briefly rallied after the UK rate decision, but then eased back as investors looked towards the BoE's February meeting.
In commodities, fears that an economic slowdown could hurt demand for oil sent the benchmark US crude price down below $94 a barrel.
But gold set a new record high of $894.90, as investors sought to hedge against inflation. The metal was further helped by the weaker tone of the dollar.
The turnaround on Wall Street came after investors had earlier found little comfort from the Bank of England's failure to cut interest rates or hawkish comments from the European Central Bank.
"European growth prospects are going to feel distinctly chillier in the coming months," said David Brown, chief European economist at Bear Stearns.
Jean-Claude Trichet, ECB president, in effect confirmed a tightening bias towards interest rates as he stated the bank was prepared to act pre-emptively against "second round" price risks. He also implied that there had been no discussion about cutting rates.
Aurelio Maccario, co-head of European economics at UniCredit, said the ECB's hawkishness was mainly aimed at indicating to trade unions that no departure from the wage moderation of recent years would be tolerated.
"The start of wage negotiations in Germany determined some key passages of the statement," Mr Maccario said. "It is clear that the ECB doesn't want to adopt a "wait-and-see" approach, rather the central bank wants to sit at the table and impact on the decision-making process."
However, some analysts felt Mr Trichet's comments amounted to little more than sabre-rattling.
"The ECB is well aware that higher rates in these circumstances would be highly inappropriate and a classic case of bad timing," said Mr Brown.
"It would be read very badly by the markets and would probably add to market instability, fuelling more risk aversion and flight to quality in the process."
Meanwhile, the BoE dashed speculation among some investors that it might sanction a rate cut on Thursday in the face of an increasingly bleak outlook for the UK economy. But analysts said the Bank was merely pausing for breath. "With substantial easing already priced in by financial markets and sterling having fallen significantly in recent weeks, the central bank probably felt that it could wait for the new information provided by its February forecast update," said Nick Kounis, senior economist at Fortis Global Markets. "A rate cut next month looks likely."
