Markets Rise on Prime Rate Cut from the Fed

The stock markets opened sharply higher Friday morning, after a surprise announcement by the Federal Reserve that it will cut its discount rate on loans to banks, by half a percentage point. The shift was announced about an hour before the New York markets opened.

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RENEE MONTAGNE, host:

This is MORNING EDITION from NPR News. Good morning, I'm Renee Montagne.

The stock markets opened sharply higher this morning following a surprise announcement by the Federal Reserve. Both the Dow Jones and the S&P 500 are up close to two percent. An hour before New York markets opened, the Fed said it would cut its discount rate on loans to banks by half a percentage point.

This is welcome news to many investors who had been expecting a huge sell off after another rough day of trading in Asia and weeks of uncertainty in the global markets.

NPR's Adam Davidson has been tracking this news all morning and joins us now. Good morning.

ADAM DAVIDSON: Good morning.

MONTAGNE: What does this announcement mean?

DAVIDSON: Well, this is not that key Fed funds rate. You know, when people say oh, the Fed cut rates or it raised the rates, they usually refer to the Fed funds rate. That is still unchanged for now. What they've changed is the discount rate. Now, this is most important symbolically. They are signaling to the market, we're taking this very seriously. We're very concerned. We're on top of the problem.

Technically, what it means is it's a specialized rates that certain qualified banks can use to borrow money from the federal government. So now they know they can borrow money more cheaply from the federal government if they have a crisis. It's kind of a signal that no matter how bad things get, banks will be able to get the money they need to operate.

MONTAGNE: And does that lead to possible further action or is this it?

DAVIDSON: I think we're - the markets are certainly pricing in and almost guarantee a further Fed action. They're meeting in a few weeks, but there's every expectation that maybe even early next week the Fed will lower that benchmark rate, you know, what's now 5.25 percent. The markets are screaming for it. They're begging for it. And it seems pretty clear this will not, in and of itself, be enough. Again, it's more symbolic than an actual change to financial markets that will fundamentally change the picture.

MONTAGNE: Well, where does that put, then, the market in this economic crisis?

DAVIDSON: Well, I mean, that's the interesting thing. To be honest, nobody really understands what's happening. There's a fundamental problem in global markets now that has existed for about a week. It's - people talk about risk and people talk about uncertainty. Risk is measurable, predictable. You know, you and I can kind of guess what Microsoft's earnings will be next quarter, something like that. We might have different guesses but they'd be within a range.

Uncertainty is a fundamental misunderstanding of the very core, fundamental issues in a market, and that's what people are feeling. They don't know what's going on.

I liken it to someone going to Vegas. You put some money on a roulette wheel or on a blackjack table and you're prepared to deal with some risk. But when you go to the ATM machine to get a hundred bucks and that's risky, and that's saying, well, there's a decent chance we're not going to give you your money. That's when you start panicking because it's that fundamental information that allows people to understand how markets work, are they working. And since people don't have that information, they're making these kind of wild, panicky moves, and that's why you see this extreme swinging back and forth. It's not that they know something we don't; it's that nobody knows anything.

MONTAGNE: Well, now that the Fed has given investors a chance to catch their breath, what - let's look at the long term and its impact that this market volatility could have on the broader economy. What would that be?

DAVIDSON: Well, there's a bunch of different scenarios that people are playing out. The truth is, again, nobody knows. This could all blow over. It could blow over today. It could blow over next week or slowly blow over, over the coming months. Or what could happen is banks won't have access to that ready cash, that liquid capital they need. They'll pull credit back, not just from subprime mortgages but from lots and lots of other activities. And you'll start seeing big companies, lots of companies go out of business. You'll start seeing economic crises in different - especially in poorer countries around the world. It could really spread to the street, or it could not. We don't know.

MONTAGNE: NPR's Adam Davidson, thanks very much.

DAVIDSON: Thank you.

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