Washington: The financial market turmoil stemming from the collapse of Wall Street giant Lehman Brothers has boosted odds for a cut in interest rates by the Federal Reserve on Tuesday, analysts said.
The failure of weekend talks to save Lehman has sparked worries about a financial tsunami, prompting the Fed to open up new liquidity to avert a knock-on effect.
Some economists said the Fed also needs to cut rates to keep credit flowing, even though last week most analysts had been expecting the Tuesday policy meeting to hold the federal funds rate at 2.0%, below the level of inflation.
“Markets are now expecting the Fed to cut rates 25 basis points tomorrow (Tuesday), although there was no real macroeconomic reason for them to do so prior to last night,” said Sherry Cooper, chief economist at BMO Capital Markets.
“One thing is certain, the Fed will do whatever it takes to calm financial markets. Inflation is no longer a major concern with oil and other commodity prices falling.”
The futures market was pricing in a 68% chance of a quarter-point cut in rates, up from a 9.0% chance last week.
Global stock markets were in a freefall amid fears of contagion from Lehman, already believed to be pressuring American International Group, one of the world’s biggest insurance firms whose shares were down over 60%.
Rating agencies Standard & Poor’s, Moody’s and Fitch all lowered AIG’s credit score, and the Wall Street Journal reported Tuesday that people close to the situation say AIG may be forced into filing for bankruptcy if it can not secure sufficient fresh funding by Wednesday.
Cary Leahey, senior US economist at Decision Economics, said he believes the Fed should fight the urge to respond to market pressure for a rate cut.
He said a rate cut might be construed as a sign of panic: “It might send a signal that they (Fed members) know something we don’t know” about the financial crisis, Leahey said.